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TABLE OF CONTENTS
PART IV
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For The Fiscal Year Ended March 4, 2017 |
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OR |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For The Transition Period From To |
Commission File Number 1-5742
RITE AID CORPORATION
(Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization) |
23-1614034 (I.R.S. Employer Identification No.) |
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30 Hunter Lane, Camp Hill, Pennsylvania (Address of principal executive offices) |
17011 (Zip Code) |
Registrant's telephone number, including area code: (717) 761-2633
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
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Common Stock, $1.00 par value | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý No o
Indicate by check mark if the registrant is not required to file reports pursuant to section 13 or section 15(d) of the Exchange Act. Yes o No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "Large Accelerated Filer," "Accelerated Filer," "Smaller Reporting Company" and "Emerging Growth Company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ý | Accelerated Filer o | Non-Accelerated Filer o (Do not check if a smaller reporting company) |
Smaller reporting company o Emerging growth company o |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
The aggregate market value of the voting and non-voting common stock of the registrant held by non-affiliates of the registrant based on the closing price at which such stock was sold on the New York Stock Exchange on August 27, 2016 was approximately $7,769,703,679. For purposes of this calculation, only executive officers and directors are deemed to be affiliates of the registrant.
As of April 17, 2017 the registrant had outstanding 1,053,663,926 shares of common stock, par value $1.00 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the registrant's annual meeting of stockholders to be held on or before July 17, 2017 are incorporated by reference into Part III.
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This report, as well as our other public filings or public statements, include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are often 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:
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We undertake no obligation to update or revise the forward-looking statements included in this report, whether as a result of new information, future events or otherwise, after the date of this report. 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 sections entitled "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of OperationsOverview and Factors Affecting Our Future Prospects" included in this Annual Report on Form 10-K.
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Overview
Rite Aid is the third largest retail drugstore chain in the United States based on both revenues and number of stores. As of March 4, 2017, we operated 4,536 stores in 31 states across the country and in the District of Columbia.
Our headquarters are located at 30 Hunter Lane, Camp Hill, Pennsylvania 17011, and our telephone number is (717) 761-2633. Our common stock is listed on the New York Stock Exchange under the trading symbol of "RAD." We were incorporated in 1968 and are a Delaware corporation.
In fiscal 2017, we continued reporting our business in two distinct segments. Our Retail Pharmacy Segment consists of Rite Aid stores, RediClinic and Health Dialog. Our Pharmacy Services Segment consists of EnvisionRx, our PBM that has been rebranded as EnvisionRxOptions ("EnvisionRx" or "EnvisionRxOptions").
Retail Pharmacy SegmentIn our Rite Aid retail stores, we sell prescription drugs and a wide assortment of other merchandise, which we call "front-end" products. In fiscal 2017, prescription drug sales accounted for 68.3% of our total drugstore sales. We believe that pharmacy operations will continue to represent a significant part of our business due to industry trends such as an aging population, increased life expectancy, anticipated growth in the federally funded Medicare Part D prescription program as "baby boomers" continue to enroll and the discovery of new and better drug therapies. We carry a full assortment of front-end products, which accounted for the remaining 31.7% of our total drug store sales in fiscal 2017. Front-end products include over-the-counter medications, health and beauty aids, personal care items, cosmetics, household items, food and beverages, greeting cards, seasonal merchandise and numerous other everyday and convenience products.
We differentiate our stores from other national chain drugstores, in part, through our wellness+ with Plenti loyalty program, our Wellness format stores, innovative merchandising, private brands and our strategic partnership with GNC, a leading retailer of vitamin and mineral supplements. We offer a wide variety of products through our portfolio of private brands, which contributed approximately 18.3% of our front-end sales in fiscal 2017.
The average size of each store in our chain is approximately 12,700 square feet, and average store size is larger for our locations in the western United States. As of March 4, 2017, 63% of our stores were freestanding; 56% of our stores included a drive-thru pharmacy; and 52% included a GNC store within a Rite Aid store.
RediClinic, based in Houston and acquired by Rite Aid in April 2014 as a 100 percent owned subsidiary, is a leading operator of retail clinics. RediClinics are staffed by board certified nurse practitioners and physician assistants, who are trained and licensed to treat common conditions and provide preventative services, in collaboration with local physicians who are affiliated with a leading health care system in each market. Patients can be treated for more than 30 common medical conditions and RediClinic's clinicians are able to write prescriptions for these conditions when appropriate. Additionally, RediClinics provide a broad range of preventive services, including screenings, medical tests, immunizations and basic physical exams.
Health Dialog, a Boston-based 100 percent owned subsidiary that Rite Aid acquired in April 2014, is a provider of healthcare coaching and disease management services to health plans and employers. Health Dialog provides these services using a call in line staffed by nurse practitioners and through an on-line platform.
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Pharmacy Services SegmentEnvisionRxOptions, a 100 percent owned subsidiary of Rite Aid, is a national, full-service PBM that also offers a broad range of pharmacy-related services. Given its rapid, recent growth and integration with Rite Aid, EnvisionRx rebranded its parent company and family of brands under EnvisionRxOptions to better reflect the breadth of capabilities it offers its customers. As a Rite Aid subsidiary, EnvisionRxOptions is a fully integrated provider with a differentiated approach to pharmacy benefits. EnvisionRx provides both transparent and traditional PBM options through its EnvisionRx and MedTrak PBM's, respectively. EnvisionRx's LakerSoftware provides a modern, scalable adjudication platform that powers both EnvisionRx and MedTrakRx, as well as other PBM's across the country that license this system. EnvisionRxOptions also offers fully integrated mail, specialty and compounding pharmacy services through EnvisionPharmacies; provides discounts for under and uninsured patients through EnvisionSavings; and serves one of the fastest growing demographics in healthcareseniors enrolled in Medicare Part D through EnvisionInsurance and its national prescription drug plan, EnvisionRxPlus.
Merger AgreementOn January 30, 2017, Walgreens Boots Alliance, Inc. (NASDAQ: WBA) ("WBA") and Rite Aid announced that they had entered into an amendment and extension of their previously announced definitive Agreement and Plan of Merger, dated as of October 27, 2015 (as amended by Amendment No. 1 thereto (the "Amendment") on January 29, 2017, the "Merger Agreement"), with Victoria Merger Sub, Inc., a Delaware corporation and a wholly owned direct subsidiary of WBA ("Victoria Merger Sub"). Pursuant to the terms and subject to the conditions set forth in the Merger Agreement, Victoria Merger Sub will merge with and into Rite Aid (the "Merger"), with Rite Aid surviving the Merger as a 100 percent owned direct subsidiary of WBA. The exact per share merger consideration will be determined based on the number of retail stores that WBA agrees to divest in connection with the parties' efforts to obtain the required regulatory approvals for the Merger, with the price set at $7.00 per share if 1,000 stores or fewer retail stores are required to be divested and at $6.50 per share if 1,200 retail stores are required to be divested (or more, if WBA agrees to sell more). If the required divestitures fall between 1,000 and 1,200 stores, then there will be a pro-rata adjustment of the price per share. While the exact per share merger consideration is not known as of the date of this report, based on discussions with the FTC regarding potential remedies after filing the preliminary proxy statement, if the Merger is completed, Rite Aid believes that the per share merger consideration would likely be $6.50 per share. WBA and Rite Aid also agreed to extend the end date under the previously announced agreement to July 31, 2017 to allow the parties additional time to obtain regulatory approval.
Asset Purchase AgreementPreviously, WBA and Rite Aid announced on December 20, 2016 that they had entered into an Asset Purchase Agreement, dated as of December 19, 2016 (the "Asset Purchase Agreement"), with AFAE, LLC, a Tennessee limited liability company and wholly owned subsidiary of Fred's ("Buyer") and Fred's (solely for the purposes set forth in the Asset Purchase Agreement). Pursuant to the terms and subject to the conditions set forth in the Asset Purchase Agreement, Rite Aid agreed to sell 865 Rite Aid stores (the "Acquired Stores") and certain specified assets related to store operations to Buyer for a purchase price of $950.0 million plus Buyer's assumption of certain liabilities of Rite Aid and its affiliates (the "Sale"). Should the divestiture of up to 1,200 stores be required to obtain regulatory approval, all parties to the Asset Purchase Agreement agree to negotiate in good faith to amend the Asset Purchase Agreement accordingly. Completion of the Sale is subject to various closing conditions, including but not limited to, the closing of the proposed acquisition of Rite Aid by WBA (the "Rite Aid Acquisition") and the Federal Trade Commission (the "FTC") having issued publicly the proposed final judgment relating to the Acquired Stores in connection with the Rite Aid Acquisition identifying Buyer as being preliminarily approved as the purchaser of the assets purchased under the Asset Purchase Agreement.
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Industry Trends
The rate of pharmacy sales growth in the United States has slowed in recent years, driven by a decline in new blockbuster drugs, a longer FDA approval process, drug safety concerns, higher copays and an increase in the use of generic (non-brand name) drugs, which are less expensive but generate higher gross margins. New drug development in the next few years is expected to be concentrated in specialty prescriptions, which are targeted toward a specific disease state. These drugs are often complex and expensive. We expect prescription usage to continue to grow in the coming years due to the aging U.S. population, increased life expectancy, "baby boomers" continuing to become eligible for the federally funded Medicare prescription program and new drug therapies. Additionally, rising U.S. healthcare costs and the shortage of primary care physicians are creating opportunities for pharmacists and drugstores to play a more active role in driving positive health outcomes for patients. Services such as immunizations, medication therapy management, chronic condition management, clinics and medication compliance counseling extend our efforts well beyond filling prescriptions. We believe that offerings such as these could gain additional momentum in a rapidly changing healthcare environment. Uncertainty regarding the Patient Protection and Affordable Care Act and the potential reduction of patients that have access to insured prescription drug coverage could have a negative impact on our business.
In terms of our traditional drug dispensing business, generic prescription drugs continue to help lower overall costs for customers and third party payors. We believe the utilization of existing generic pharmaceuticals will continue to increase, although the pace of introduction of new generic drugs is expected to slow. The gross profit from a generic drug prescription in the retail drugstore industry is generally greater than the gross profit from a brand drug prescription. However, the sale amount can be substantially less and can impact our overall revenues and same store sales.
The retail drugstore industry is highly competitive. We believe that the competitive advantages from the increasing trend toward vertical integration resulting from the combination of retail pharmacy companies with pharmacy benefit managers, such as CVS Health, and aggressive generic pricing programs at competitors such as Wal-Mart and various supermarket chains will further increase competitive pressures in the industry. Front end product pricing has continued to be highly promotional in the retail drugstore business, which contributes to additional competitive pressures.
The retail drugstore industry relies significantly on third party payors. Third party payors, including the Medicare Part D plans and the state-sponsored Medicaid and related managed care Medicaid agencies, at times change the eligibility requirements of participants or reduce certain reimbursement rates. These changes and reductions are expected to continue. Medicare Part D plans have also introduced plans that have restricted network options, under which a patient can elect a plan with a lower copay in exchange for the choice to use a limited number of pharmacies to fill their prescriptions. In order to participate in these restricted networks, retail pharmacies generally have to accept lower reimbursement rates. We expect the usage of these restricted network plans to continue to increase. When third party payors, including the Medicare Part D program and state-sponsored Medicaid agencies, reduce the number of participants and/or reduce their reimbursement rates, sales and margins in the industry could be reduced, and profitability of the industry adversely affected. These possible adverse effects can be partially offset by lowering our product cost, controlling expenses, dispensing more higher margin generics, finding new revenue streams through pharmacy services and dispensing more prescriptions overall.
Strategy
During fiscal 2017, we experienced an erosion of pharmacy margin due to reimbursement rate pressures, an inability to offset these pressures with generic drug purchasing efficiencies and declining prescription counts due primarily to our lack of participation in Medicare Part D restricted networks.
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In fiscal 2018, as we work to complete our merger with WBA our strategy will be to offset what we expect to be further reimbursement rate pressure through initiatives to grow sales as well as cost control measures.
Following are descriptions of some of our key initiatives:
Expanded Healthcare ServicesIn fiscal 2017, we continued to expand the role of our Rite Aid pharmacists in delivering wellness services that go beyond filling prescriptions. A key area of focus has been our immunizations program, which has grown significantly in recent years. In fiscal 2017, our pharmacists administered more than 4.0 million immunizations, including more than 3.2 million flu shots and approximately 0.8 million other immunizations that protect against conditions like shingles, pneumonia and whooping cough. Immunizations will continue to be a key priority in fiscal 2018.
At the same time, helping our patients take their medications as prescribed continues to be a critical opportunity to improve their health and wellness while also lowering healthcare costs by avoiding illnesses and hospital visits. To support our ongoing efforts, we've launched One Trip Refills, which allows our patients to refill all of their monthly maintenance medications by making a single trip to the pharmacy. The program has been well received by our patients, and when combined with our existing services to send alerts via text message, e-mail or phone when a prescription is ready to be picked up, it creates a more patient-friendly experience for our Rite Aid customers.
An important part of our retail healthcare strategy continues to be finding ways to integrate our expanded suite of healthcare assets with our base of conveniently located retail pharmacies to deliver a higher level of care and service in our communities. This includes leveraging our store base and the capabilities of EnvisionRxOptions in our efforts to create compelling pharmacy offerings across retail, specialty and mail-order channels; deliver cost-effective solutions to employers and health plans; and drive growth. When combined with Rite Aid's retail platform, EnvisionRxOptions' comprehensive suite of services allows Rite Aid to provide additional value and broader choice to customers, patients and payors and will better position us to meet their needs. In fiscal 2017, Rite Aid and EnvisionRxOptions introduced Rx90, a program that gives EnvisionRx PBM patients the option to fill their 90-day prescriptions either through its mail order facility or at a comprehensive network of retail stores, including Rite Aid.
Our Pharmacy Services segment's business strategy centers on providing innovative pharmaceutical solutions and quality client service in order to help improve clinical outcomes for our clients' plan members while assisting our clients and their plan members in better managing overall health care costs. Our clients are primarily employers, insurance companies, unions, government employee groups, health plans, Managed Medicaid plans, Medicare plans, and other sponsors of health benefit plans, and individuals throughout the United States. Our goal is to produce superior results for our clients and their plan members by leveraging our expertise in core PBM services, including: plan design offerings and administration, formulary management, Medicare Part D services, mail order, specialty pharmacy services, retail pharmacy network management services, clinical services, disease management services, and other spend management.
RediClinic also represents a key component of our efforts to expand Rite Aid's retail healthcare offering. As of March 4, 2017, we had 63 RediClinics operating in Rite Aid stores throughout the Philadelphia, Seattle and Baltimore/Washington, D.C. markets and in New Jersey, through our recently announced joint venture with Hackensack Meridian Health. Including our locations in Texas, we operated a total of 99 RediClinics at the end of fiscal 2017.
wellness+ with PlentiSince the launch of wellness+ in April 2010, this free loyalty program has provided customers and patients with the opportunity to earn significant discounts and wellness rewards in return for being loyal Rite Aid shoppers. Enrolled members earn rewards based on the accumulation of points for certain front-end and prescription purchases. The program has been well received by Rite
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Aid customers and continues to provide significant value to members earning enough points to reach the Gold or Silver tier levels. Gold members, for example, receive a tiered discount of 20-percent off most items in the store for an entire year. In addition, all wellness+ members receive exclusive sale pricing and wellness rewards.
Plenti, which at Rite Aid has been incorporated into wellness+ to create wellness+ with Plenti, allows consumers to earn and use points across a range of well-known brands in different industries. Through wellness+ with Plenti, our customers can use one card and earn two kinds of points. Members continue to earn wellness+ points toward various benefits at Rite Aid including discounts of up to 20% off storewide, exclusive sale prices and 24/7 access to a pharmacist. Members are also able to earn Plenti points whenever they make qualifying purchases at Rite Aid and all other Plenti partners and these points can be used for savings at Rite Aid as well as certain other Plenti partners including AT&T, ExxonMobil, Macy's, Nationwide, Direct Energy, Hulu and American Express. Customers have at least two years to use their Plenti points.
We currently have over 30 million customers enrolled in wellness+ with Plenti and millions more enrolled by our partners throughout the coalition. In addition, 55% of transactions at Rite Aid now involve a wellness+ with Plenti card. We've also been highly successful in converting our gold and silver wellness+ membersour most loyal and valuable customersto the enhanced program.
Wellness Store RemodelsIn fiscal 2017, we continued to strengthen Rite Aid as a wellness destination by completing additional Wellness store remodels. As a result, our total number of Wellness stores reached 2,418 by the end of the fiscal year, which means that over 50% of all Rite Aid stores are now Wellness stores. We also opened 12 new stores and did 24 relocations, all in our groundbreaking Wellness format, which offers improved interior design, expanded clinical pharmacy services, innovative merchandising and new wellness product offerings. Our customers have responded favorably to this unique store format, with our Wellness stores continuing to outperform the rest of our chain in terms of both front-end same store sales and same store prescription count growth.
We plan to complete 200 additional Wellness remodels in fiscal 2018 along with 26 relocations and 5 new store openings. We believe these efforts represent a cost-effective way to strengthen our store base, grow sales and offer our customers an engaging wellness experience.
Prescription File PurchasesIn fiscal 2017, we spent $56.8 million on the purchase of prescription files. This represented a decrease in spend from previous years, as the pending merger with WBA limited our file buy opportunities. We will continue to purchase prescription files in fiscal 2018 as they typically deliver a strong return on investment.
Drug Purchasing and Distribution EfficienciesIn fiscal 2017, we continued to partner with McKesson for pharmaceutical purchasing and distribution. Under this arrangement, McKesson assumes responsibility for purchasing all of the brand and generic medications that we dispense in our stores as well as delivering those medications to our over 4,500 store locations. This drug purchasing and distribution arrangement helps us manage product costs and working capital while optimizing in-stock positions in our stores.
Cost ControlIn fiscal 2018, we will continue to look for ways to control our costs in order to help mitigate the impact that declining reimbursement rates has on our business. Our cost control initiatives include the expansion of our central fill capabilities and our shared prescription quality assurance program, both of which are designed to utilize pharmacist labor in a more efficient manner. Our centralized indirect procurement group will continue to target not-for-resale purchasing opportunities.
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Products and Services
Sales of prescription drugs for our Retail Pharmacy segment represented approximately 68.3%, 69.1% and 68.8% of our total drugstore sales in fiscal years 2017, 2016 and 2015, respectively. In fiscal years 2017, 2016 and 2015, prescription drug sales were $18.2 billion, $18.4 billion and $18.1 billion, respectively. See "Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements.
We carry a full assortment of non-prescription, or front end, products. The types and number of front end products in each store vary, and selections are based on customer needs and preferences and available space. No single front end product category contributed significantly to our sales during fiscal 2017. Our Retail Pharmacy segment's principal classes of products in fiscal 2017 were the following:
Product Class
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Percentage of Sales |
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Prescription drugs |
68.3 | % | ||
Over-the-counter medications and personal care |
10.2 | % | ||
Health and beauty aids |
4.8 | % | ||
General merchandise and other |
16.7 | % |
We offer a wide variety of products under our private brands in virtually every department. We intend to increase our private brand sales in fiscal 2018 by expanding our product lines and enhancing our marketing efforts. We believe that our assortment is differentiated and a compelling value to our customers based on our emphasis on high quality standards and everyday/promotional pricing.
We have a strategic alliance with GNC under which we have opened over 2,300 GNC stores within Rite Aid stores as of March 4, 2017 and have a contractual commitment to open at least 134 additional GNC stores within Rite Aid stores by December 2019. We incorporate the GNC stores within Rite Aid stores concept into many of our new and relocated stores and into many of our Wellness remodels. GNC is a leading nationwide retailer of vitamin and mineral supplements, personal care, fitness and other health-related products.
Through our 100 percent owned subsidiary, EnvisionRx, we offer a broad range of pharmacy-related services. In addition to its transparent and traditional PBM offerings through the EnvisionRx and MedTrak PBMs, EnvisionRx also offers fully integrated mail-order and specialty pharmacy services through EnvisionPharmacies. Through its Envision Insurance Company, EnvisionRx also serves one of the fastest-growing demographics in healthcare: seniors enrolled in Medicare Part D. In addition, EnvisionRx, through its state of the art Laker Software, performs prescription adjudication services for its own as well as other PBM's.
The Company, through its Health Dialog subsidiary, provides health care coaching and disease management services to health plans and employers. Health Dialog provides these services using a call in line staffed by nurse practitioners and through an on-line platform.
Technology
All of our stores are integrated into a common information system, which enables our customers to fill or refill prescriptions in any of our stores throughout the country, reduces chances of adverse drug interactions, and enables our pharmacists to fill prescriptions more accurately and efficiently. Our customers may also order prescription refills over the Internet through our website, www.riteaid.com, our mobile app, or over the phone through our telephonic automated refill systems for pick up at a Rite Aid store. We have automated pharmacy dispensing units in high volume stores, which are linked to our pharmacists' computers that fill and label prescription drug orders. We developed central fill technology to facilitate the automated picking, packaging, and labeling of prescriptions in a central filling location, which are sent to certain retail stores for delivery to the customer. We have also
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developed workload sharing technology within our stores, whereby stores within a close proximity can shift filling volume to stores with excess capacity. The efficiency of these processes allows our pharmacists to spend more time consulting with and answering our customers' questions and concerns about their prescription medications and health conditions. Additionally, each of our stores employs point-of-sale technology that supports sales analysis and recognition of customer trends. This same point-of-sale technology facilitates the maintenance of perpetual inventory records which, together with our sales analysis, drives our automated inventory replenishment process.
We continue to embrace technology as a way to enhance the customer experience. Our mobile app, which is available for download for both the Android and iPhone platforms, allows our customers to use their smartphones to manage their wellness + account, refill prescriptions, access the weekly circular to view sale items, order photo prints and locate a nearby Rite Aid store. We have continued to strengthen our presence on social media sites such as Facebook, Twitter and Pinterest through unique promotions and contests.
Sources and Availability of Raw Materials
Beginning in fiscal 2015, under our pharmaceutical purchasing and delivery arrangement ("Purchasing and Delivery Arrangement") with limited exceptions, we purchased all of our branded pharmaceutical products and almost all of our generic (non-brand name) pharmaceutical products from McKesson Corporation ("McKesson"). If our relationship with McKesson were disrupted, we could temporarily have difficulty filling prescriptions for branded and generic drugs until we executed a replacement wholesaler agreement or developed and implemented self-distribution processes.
We purchase our non-pharmaceutical merchandise from numerous manufacturers and wholesalers. We believe that competitive sources are readily available for substantially all of the non-pharmaceutical merchandise we carry and that the loss of any one supplier would not have a material effect on our business.
We sell private brand and co-branded products that generally are supplied by numerous competitive sources. The Rite Aid and GNC co-branded PharmAssure vitamin and mineral supplement products and the GNC branded vitamin and mineral supplement products that we sell in our stores are developed by GNC, and along with our Rite Aid brand vitamin and mineral supplements, are manufactured by GNC.
Customers and Third Party Payors
During fiscal 2017, our stores filled approximately 302 million prescriptions and served an average of 2.0 million customers per day. The loss of any one customer would not have a material adverse impact on our results of operations.
In fiscal 2017, 98.2% of our pharmacy sales were to customers covered by third party payors (such as insurance companies, prescription benefit management companies, government agencies, private employers or other managed care providers) that agree to pay for all or a portion of a customer's eligible prescription purchases based on negotiated and contracted reimbursement rates. During fiscal 2017, the top five third party payors accounted for approximately 75.6% of our pharmacy sales. The largest third party payor, Caremark, represented 27.3% of our pharmacy sales.
During fiscal 2017, Medicaid and related managed care Medicaid payors sales were approximately 19.8% of our pharmacy sales, of which the largest single Medicaid payor was approximately 1.2% of our pharmacy sales. During fiscal 2017, approximately 33.0% of our pharmacy sales were to customers covered by Medicare Part D.
Through our Pharmacy Services segment we provide innovative pharmaceutical solutions for our clients which are primarily employers, insurance companies, unions, government employee groups,
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health plans, Managed Medicaid plans, Medicare plans, and other sponsors of health benefit plans, and individuals throughout the United States.
Competition
The retail drugstore industry is highly competitive. We compete with, among others, retail drugstore chains, independently owned drugstores, supermarkets, mass merchandisers, discount stores, wellness offerings, dollar stores and mail order pharmacies. We compete on the basis of store location and convenient access, customer service, product selection and price. We believe continued consolidation of the drugstore industry, and the aggressive discounting of generic drugs by supermarkets and mass merchandisers will further increase competitive pressures in the industry.
Marketing and Advertising
In fiscal 2017, marketing and advertising expense was approximately $289.9 million, which was spent primarily on weekly circular, digital, customer relationship, and Pharmacy advertising. Our marketing and advertising activities centered primarily on the following:
Under the umbrella of our "With Us It's Personal" positioning, we promote educational programs focusing on specific health conditions and pharmacy and clinical services to drive brand preference including our One Trip Refills, immunization and Quit For You smoking cessation programs. We believe all of these programs will help us improve customer satisfaction and grow profitable sales.
Associates
We believe that our relationships with our associates are good. As of March 4, 2017, we had approximately 87,000 Retail Pharmacy segment associates: 11% were pharmacists, 42% were part-time and 26% were represented by unions. Additionally, we have approximately 1,700 Pharmacy Services segment associates. Associate satisfaction is critical to our success. Annually we survey our associates to obtain feedback on various employment-related topics, including job satisfaction and their understanding of our core values and mission.
The number of graduates from U.S. Schools of Pharmacy is largely meeting our workforce demand. However, pharmacist employment opportunities still exist in certain areas.
Research and Development
We do not make significant expenditures for research and development.
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Licenses, Trademarks and Patents
The Rite Aid name is our most significant trademark and the most important factor in marketing our stores and private brand products. We hold licenses to sell beer, wine and liquor, cigarettes and lottery tickets. As part of our strategic alliance with GNC, we have a license to operate GNC "stores-within-Rite Aid-stores." We also hold licenses to operate our pharmacies and our distribution facilities. Through our 100% owned subsidiary EnvisionRx, we hold a license to conduct Medicare Part D business with CMS.
Collectively, these licenses are material to our operations.
Seasonality
We experience moderate seasonal fluctuations in our results of operations concentrated in the first and fourth fiscal quarters as the result of the concentration of the cough, cold and flu season and the holidays. We tailor certain front end merchandise to capitalize on holidays and seasons. We increase our inventory levels during our third fiscal quarter in anticipation of the seasonal fluctuations described above. Our results of operations in the fourth and first fiscal quarters may fluctuate based upon the timing and severity of the cough, cold and flu season, both of which are unpredictable.
Regulation
Our business is subject to federal, state and local laws, regulations, and administrative practices concerning the provision of and payment for health care services, including, without limitation: federal, state and local licensure and registration requirements concerning the operation of pharmacies and the practice of pharmacy; Medicare, Medicaid and other publicly financed health benefit plan regulations prohibiting kickbacks, beneficiary inducement and the submission of false claims; the Patient Protection and Affordable Care Act (the "ACA"); regulations of the U.S. Food and Drug Administration and the U.S. Drug Enforcement Administration, including regulations governing the purchase, sale, storing and dispensing of controlled substances and other products, as well as regulations promulgated by state and other federal agencies concerning automated outbound contacts such as phone calls, text messages and emails and the sale, advertisement and promotion of the products we sell, including tobacco and alcoholic beverages.
Our business is also subject to patient privacy and other obligations, including corporate, pharmacy and associate responsibility imposed by the Health Insurance Portability and Accountability Act. As a covered entity, we are required to implement privacy standards, train our associates on the permitted uses and disclosures of protected health information, provide a notice of privacy practice to our pharmacy customers and permit pharmacy customers to access and amend their records and receive an accounting of disclosures of protected health information. We are also subject to federal and state privacy and data security laws with respect to our receipt, use and disclosure by us of personally identifiable information, which laws require us to provide appropriate privacy and security safeguards for such information. In addition, we are also subject to the Payment Card Industry Data Security Standard promulgated by the payment card industry in connection with handling credit card data. This standard contains requirements devised to aid entities that process, store or transmit credit card information to maintain a secure environment.
We are also subject to laws governing our relationship with our associates, including health and safety, minimum wage requirements, overtime, working conditions, equal employment opportunity and unionizing efforts.
In addition, in connection with the ownership and operations of our stores, distribution centers and other sites, we are subject to laws and regulations relating to the protection of the environment and health and safety matters, including those governing the management and disposal of hazardous substances and the cleanup of contaminated sites.
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We are subject to federal, state, and local statutes and regulations, which govern PBM operations. In addition, certain quasi-regulatory organizations, including the National Association of Boards of Pharmacy and the National Association of Insurance Commissioners ("NAIC") have issued model regulations or may propose future regulations concerning PBMs and/or PBM activities. Similarly, credentialing organizations such as the National Committee for Quality Assurance ("NCQA") and the Utilization Review Accreditation Commission ("URAC") may establish voluntary standards regarding PBM or specialty pharmacy activities. While the actions of these quasi-regulatory or standard-setting organizations do not have the force of law, they may influence states to adopt their requirements or recommendations and influence client requirements for PBM or specialty pharmacy services. Moreover, any standards established by these organizations could also impact health plan clients and/or the services provided to them. PBMs also operate within the governance set forth by the Medicare Part D program, which makes prescription drug coverage available to eligible Medicare beneficiaries through private insurers. This program regulates all aspects of the provision of Medicare drug coverage, including enrollment, formularies, pharmacy networks, marketing, and claims processing. The Medicare Part D program has undergone significant legislative and regulatory changes since its inception, and continues to attract a high degree of legislative and regulatory scrutiny. The applicable government rules and regulations are expected to continue to evolve in the future.
Corporate Governance and Internet Address
We recognize that good corporate governance is an important means of protecting the interests of our stockholders, associates, customers and the community. We have closely monitored and implemented relevant legislative and regulatory corporate governance reforms, including provisions of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley"), the rules of the SEC interpreting and implementing Sarbanes-Oxley and the corporate governance listing standards of the NYSE.
Our corporate governance information and materials, including our Certificate of Incorporation, Bylaws, Corporate Governance Guidelines, the charters of our Audit Committee, Compensation Committee and Nominating and Governance Committee, our Code of Ethics for the Chief Executive Officer and Senior Financial Officers, our Code of Ethics and Business Conduct and our Related Person Transaction Policy are posted on the corporate governance section of our website at www.riteaid.com and are available in print upon request to Rite Aid Corporation, 30 Hunter Lane, Camp Hill, Pennsylvania 17011, Attention: Corporate Secretary. Our Board will regularly review corporate governance developments and modify these materials and practices as warranted.
Our website also provides information on how to contact us and other items of interest to investors. We make available on our website, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, Extensible Business Reporting Language ("XBRL") data files of our annual report and quarterly reports beginning with our fiscal 2015 first quarter 10-Q, current reports on Form 8-K and all amendments to these reports, as soon as reasonably practicable after we file these reports with, or furnish them to, the SEC. We do not intend for the information contained on our website to be part of this annual report on Form 10-K.
Factors Affecting our Future Prospects
Set forth below is a description of certain risk factors which we believe may be relevant to an understanding of us and our business. Security holders are cautioned that these and other factors may affect future performance and cause actual results to differ from those which may be anticipated. See "Cautionary Statement Regarding Forward-Looking Statements."
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Risks Related to our Financial Condition
Economic conditions may adversely affect our industry, business and results of operations.
Economic uncertainty has and could further lead to reduced consumer spending. If consumer spending decreases or does not grow, we may see further decline in our same store sales. In addition, reduced or flat consumer spending may drive us and our competitors to offer additional products at promotional prices, which would have a negative impact on our gross profit. We operate a number of stores in areas that are experiencing a lower or slower recovery than the economy on a national level. A continued softening or slow recovery in consumer spending may adversely affect our industry, business and results of operations. Reduced revenues as a result of decreased consumer spending may also reduce our liquidity and otherwise hinder our ability to implement our long term strategy.
We are highly leveraged. Our substantial indebtedness could limit cash flow available for our operations and could adversely affect our ability to service debt or obtain additional financing if necessary.
We had, as of March 4, 2017, $7.3 billion of outstanding indebtedness and stockholders' equity of $614.1 million. We also had additional borrowing capacity under our $3.7 billion amended and restated senior secured revolving credit facility (the "Amended and Restated Senior Secured Credit Facility" or "revolver") of $1,207.7 million, net of outstanding letters of credit of $62.3 million. Our earnings were sufficient to cover fixed charges for fiscal 2017, 2016, 2015 and 2014 by $48.3 million, $278.2 million, $426.7 million and $233.4 million, respectively. However, our earnings were insufficient to cover fixed charges and preferred stock dividends for fiscal 2013 by $14.0 million.
Our high level of indebtedness will continue to restrict our operations. Among other things, our indebtedness will:
Our ability to meet our cash requirements, including our debt service obligations, is dependent upon our ability to maintain our operating performance, which will be subject to general economic and competitive conditions and to financial, business and other factors, many of which are beyond our control. We cannot provide assurance that our business will generate sufficient cash flow from operations to fund our cash requirements and debt service obligations.
We believe we have adequate sources of liquidity to meet our anticipated requirements for working capital, debt service and capital expenditures through fiscal 2018 and have no significant debt maturities prior to January 2020. However, if our operating results, cash flow or capital resources prove inadequate, or if interest rates rise significantly, we could face liquidity constraints. If we are unable to service our debt or experience a significant reduction in our liquidity, we could be forced to reduce or delay planned capital expenditures and other initiatives, sell assets, restructure or refinance our debt or seek additional equity capital, and we may be unable to take any of these actions on satisfactory terms or in a timely manner. Further, any of these actions may not be sufficient to allow us to service our debt obligations or may have an adverse impact on our business. Our existing debt agreements limit our ability to take certain of these actions. Our failure to generate sufficient operating cash flow to pay our debts or refinance our indebtedness could have a material adverse effect on us.
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Borrowings under our senior secured credit facility are based upon variable rates of interest, which could result in higher expense in the event of increases in interest rates.
As of March 4, 2017, $3.4 billion of our outstanding indebtedness bore interest at a rate that varies depending upon the London Interbank Offered Rate ("LIBOR"). Borrowings under our Second Lien facilities (the $470.0 million Tranche 1 Term Loan due August 2020 (the "Tranche 1 Term Loan") and the $500.0 million Tranche 2 Term Loan due June 2021 (the "Tranche 2 Term Loan")) are subject to a minimum LIBOR floor of 100 basis points. Borrowings under our Amended and Restated Senior Secured Credit Facility are most sensitive because they are not subject to a minimum LIBOR floor. If LIBOR rises, the interest rates on outstanding debt will increase. Therefore an increase in LIBOR would increase our interest payment obligations under those loans and have a negative effect on our cash flow and financial condition. We currently do not maintain hedging contracts that would limit our exposure to variable rates of interest.
The covenants in the instruments that govern our current indebtedness may limit our operating and financial flexibility.
The covenants in the instruments that govern our current indebtedness limit our ability to:
The Amended and Restated Senior Secured Credit Facility contains covenants which place restrictions on the incurrence of debt beyond the restrictions described above, the payment of dividends, sale of assets, mergers and acquisitions and the granting of liens. Our Amended and Restated Senior Secured Credit Facility has a financial covenant which requires us to maintain a minimum fixed charge coverage ratio. The covenant requires that, if availability under the revolver (a) on any date is less than $200.0 million, or (b) for three consecutive business days is less than $250.0 million, we maintain a minimum fixed charge coverage ratio of 1.00 to 1.00. As of March 4, 2017, we had availability under our revolver of $1,207.7 million, our fixed charge coverage ratio was greater than 1.00 to 1.00, and we were in compliance with the senior secured credit facility's financial covenant. Upon closing of the Merger, we expect that all amounts due under the Amended and Restated Senior Secured Credit Facility, Tranche 1 Term Loan and Tranche 2 Term Loan will be paid in accordance with the terms of the Merger Agreement (See "Management's Discussion and Analysis of Financial Condition and Results of OperationsFuture Liquidity").
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Our stockholders will experience dilution if we issue additional common stock.
The Merger Agreement limits our ability to issue additional capital stock, subject to certain exceptions. However, any additional future issuances of common stock will reduce the percentage of our common stock owned by investors who do not participate in such issuances. In most circumstances, stockholders will not be entitled to vote on whether we issue additional shares of common stock. The market price of our common stock could decline as a result of issuances of a large number of shares of our common stock or the perception that such issuances could occur.
Risks Related to our Operations
We need to improve our operations in order to improve our financial condition, but our operations will not improve if we cannot effectively implement our business strategy or if our strategy is negatively affected by worsening economic conditions.
We have not yet achieved the sales productivity level of our major competitors. We believe that improving the sales of existing stores is important to improving profitability and operating cash flow. If we are not successful in implementing our strategies, including our efforts to increase sales and further reduce costs, or if our strategies are not effective, we may not be able to improve our operations. In addition, any further adverse change or continued weakness in general economic conditions or major industries can adversely affect drug benefit plans and reduce our pharmacy sales. Adverse changes in general economic conditions could affect consumer buying practices and consequently reduce our sales of front end products, and cause a decrease in our profitability. Failure to improve operations or weakness in major industries or general economic conditions would adversely affect our results of operations, financial condition and cash flows and our ability to make principal or interest payments on our debt.
We purchase all of our brand and generic drugs from a single wholesaler. A disruption in this relationship may have a negative effect on us.
We purchase all of our brand prescription and, with limited exceptions, all of our generic drugs from a single wholesaler, McKesson. Because McKesson acts as a wholesaler for drugs purchased from ultimate manufacturers worldwide, any disruption in the supply of a given drug, including supply shortages of key ingredients, or regulatory actions by domestic or foreign governmental agencies, or specific actions taken by drug manufacturers, could adversely impact McKesson's ability to fulfill our demands, which could adversely affect us. Pharmacy sales represented approximately 68.3% of our total drugstore sales during fiscal 2017. While we believe that alternative sources of supply for most generic and brand name pharmaceuticals are readily available, a significant disruption in our relationship with McKesson could make it difficult for us to continue to operate our business on a regular basis until we executed a replacement wholesaler agreement or developed and implemented self-distribution processes. We believe we could obtain and qualify alternative sources, including through self-distribution, for substantially all of the prescription drugs we sell on an acceptable basis, and accordingly that the impact of any disruption would be temporary.
A significant disruption in our computer systems or a cyber security breach could adversely affect our operations.
We rely extensively on our computer systems, including those used by EnvisionRx, RediClinic, and Health Dialog, to manage our ordering, pricing, point-of-sale, inventory replenishment and other processes. Our systems have been subject to attack by perpetrators of random or targeted malicious technology-related events, such as cyberattacks, computer viruses, worms, bot attacks or other destructive or disruptive software and attempts to misappropriate customer information, including credit card information. These sorts of attacks could subject our systems to damage or interruption
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from power outages, computer and telecommunications failures, computer viruses, cyber security breaches, vandalism, coordinated cyber security attacks, severe weather conditions, catastrophic events and human error, and our disaster recovery planning cannot account for all eventualities. Although we deploy an information security program that is developed with a multi-layered approach to address information security threats and vulnerabilities, including ones from a cyber security standpoint, designed to protect confidential information against data security breaches, a compromise of our information security controls or of those businesses with whom we interact, which results in confidential information being accessed, obtained, damaged or used by unauthorized or improper persons, could harm our reputation and expose us to regulatory actions and claims from customers and clients, financial institutions, payment card associations and other persons, any of which could adversely affect our business, financial position and results of operations. Moreover, a data security breach could require that we expend significant resources related to our information systems and infrastructure, and could distract management and other key personnel from performing their primary operational duties. We could also be adversely impacted by any significant disruptions in the systems of third parties we interact with, including key payors and vendors. If our systems are damaged, fail to function properly or otherwise become unavailable, we may incur substantial costs to repair or replace them, and may experience loss of critical data and interruptions or delays in our ability to perform critical functions, which could adversely affect our business and results of operations. Any compromise or breach of our data security, whether external or internal, or misuse of customer, associate, supplier or our data could also result in a violation of applicable privacy, information security, and other laws, significant legal and financial exposure, fines or lawsuits, damage to our reputation, loss or misuse of the information and a loss of confidence in our security measures, which could harm our business. Although we maintain cyber security insurance, we cannot assure you that the coverage limits under our insurance program will be adequate to protect us against future claims. In addition, as the regulatory environment related to information security, data collection and use, and privacy becomes increasingly rigorous, with new and constantly changing requirements applicable to our business, compliance with those requirements could also result in additional costs.
We are subject to payment-related risks that could increase our operating costs, expose us to fraud or theft, subject us to potential liability and potentially disrupt our business.
We accept payments using a variety of methods, including cash, checks, credit and debit cards, gift cards and mobile payment technology, and we may accept new forms of payment over time. Acceptance of these payment options subjects us to rules, regulations, contractual obligations and compliance requirements, including payment network rules and operating guidelines, data security standards and certification requirements, and rules governing electronic funds transfers. These requirements may change over time or be reinterpreted, making compliance more difficult or costly. For certain payment methods, including credit and debit cards, we pay interchange and other fees, which may increase over time and raise our operating costs. We rely on third parties to provide payment processing services, including the processing of credit cards, debit cards, and other forms of electronic payment. If these companies become unable to provide these services to us, or if their systems are compromised, it could potentially disrupt our business. The payment methods that we offer also subject us to potential fraud and theft by criminals, who are becoming increasingly more sophisticated, seeking to obtain unauthorized access to or exploit weaknesses that may exist in the payment systems. If we fail to comply with applicable rules or requirements for the payment methods we accept, or if payment-related data is compromised due to a breach or misuse of data, we may be liable for costs incurred by payment card issuing banks and other third parties or subject to fines and higher transaction fees, or our ability to accept or facilitate certain types of payments may be impaired. In addition, our customers could lose confidence in certain payment types, which may result in a shift to other payment types or potential changes to our payment systems that may result in higher costs. As a result, our business and operating results could be adversely affected.
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If we fail to protect the security of personal information about our customers and associates, we could be subject to costly government enforcement actions or private litigation.
Through our sales and marketing activities, we collect and store certain personal information that our customers provide to purchase products or services, enroll in promotional programs, register on our web site, or otherwise communicate and interact with us. We also gather and retain information about our associates in the normal course of business. We may share information about such persons with vendors that assist with certain aspects of our business. We also participate in the Plenti coalition with American Express, in which we provide detailed customer information to allow them to administer the coalition program. Despite instituted safeguards for the protection of such information, security could be compromised and confidential customer or business information misappropriated, for which we have paid related penalties in the past. Loss of customer or business information could disrupt our operations, damage our reputation, and expose us to claims from customers, financial institutions, payment card associations and other persons, any of which could have an adverse effect on our business, financial condition and results of operations. In addition, compliance with more rigorous privacy and information security laws and standards may result in significant expense due to increased investment in technology and the development of new operational processes.
Risks Related to the Retail Pharmacy and PBM Industries in which we Operate
The markets in which we operate are very competitive and further increases in competition could adversely affect us.
We face intense competition with local, regional and national companies, including other drugstore chains, independently owned drugstores, supermarkets, mass merchandisers, dollar stores and internet pharmacies. Competition from discount stores has significantly increased during the past few years. Some of our competitors have or may merge with or acquire pharmaceutical services companies, pharmacy benefit managers, mail order facilities or enter into strategic partnership alliances with wholesalers or pharmacy benefit managers, which may further increase competition. We may not be able to effectively compete against them because our existing or potential competitors may have financial and other resources that are superior to ours. We also face competition from other PBMs, including large, national PBMs, PBMs owned by national health plans and smaller standalone PBMs. Certain of these competitors entered into the pharmacy benefit management industry before us, and there is no assurance that we will successfully compete with entities with more established pharmacy benefit management businesses. Further, we may be at a competitive disadvantage because we are more highly leveraged than our competitors. The ability of our stores to achieve profitability depends on their ability to achieve a critical mass of loyal, repeat customers. We cannot assure you that we will be able to continue to effectively compete in our markets or increase our sales volume in response to further increased competition.
Consolidation in the healthcare industry could adversely affect our business, financial condition and results of operations.
Many organizations in the healthcare industry, including pharmacy benefit managers, have consolidated to create larger healthcare enterprises with greater market power, which has resulted in greater pricing pressures. If this consolidation trend continues, it could give the resulting enterprises even greater bargaining power, which may lead to further pressure on the prices for our products and services. If these pressures result in reductions in our prices, our business will become less profitable unless we are able to achieve corresponding reductions in costs or develop profitable new revenue streams. We expect that market demand, government regulation, third-party reimbursement policies, government contracting requirements, and societal pressures will continue to cause the healthcare industry to evolve, potentially resulting in further business consolidations and alliances among the
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industry participants we engage with, which may adversely impact our business, financial condition and results of operations.
The availability of pharmacy drugs is subject to governmental regulations.
The continued conversion of various prescription drugs, including potential conversions of a number of popular medications, to over-the-counter medications may reduce our pharmacy sales and customers may seek to purchase such medications at non-pharmacy stores. Also, if the rate at which new prescription drugs become available slows or if new prescription drugs that are introduced into the market fail to achieve popularity, our pharmacy sales may be adversely affected. The withdrawal of certain drugs from the market or concerns about the safety or effectiveness of certain drugs or negative publicity surrounding certain categories of drugs may also have a negative effect on our pharmacy sales or may cause shifts in our pharmacy or front end product mix.
Changes in third party reimbursement levels for prescription drugs and changes in industry pricing benchmarks could reduce our margins and have a material adverse effect on our business.
Sales of prescription drugs reimbursed by third party payors, including the Medicare Part D plans and state sponsored Medicaid and related managed care Medicaid agencies, represented 98.2% of our pharmacy sales in our Retail Pharmacy segment in fiscal 2017.
The continued efforts of the Federal government, health maintenance organizations, managed care organizations, pharmacy benefit management companies, other State and local government entities, and other third-party payors to reduce prescription drug costs and pharmacy reimbursement rates, as well as litigation relating to how drugs are priced, may impact our profitability. In addition, some of these entities may offer pricing terms that we may not be willing to accept or otherwise restrict our participation in their networks of pharmacy providers. Any significant loss of third-party business could have a material adverse effect on our business and results of operations. In particular, there has been a growth in the number of preferred Medicare Part D networks, many of which we are excluded from participating in. Decreased reimbursement payments to retail and mail order pharmacies for generic drugs has caused a reduction in our generic profit rate. Historically, the effect of this trend has been mitigated by our efforts to negotiate reduced acquisition costs of generic pharmaceuticals with manufacturers. Additionally, it has resulted in us providing contractual financial performance guarantees to certain of our PBM clients with respect to minimum generic drug price discounts for our retail pharmacy network and mail order pharmacy. Any inability to achieve guaranteed minimum generic drug price discounts provided to our PBM clients could have an adverse effect on our results of operations.
In addition, it is possible that the pharmaceutical industry or regulators may evaluate and/or develop an alternative pricing reference to replace Average Wholesale Price ("AWP"), which is the pricing reference used for many of our PBM client contracts, pharmaceutical manufacturer rebate agreements, retail pharmacy network contracts, specialty payor agreements and other contracts with third party payors in connection with the reimbursement of drug payments. Future changes to the use of AWP or to other published pricing benchmarks used to establish pharmaceutical pricing, including changes in the basis for calculating reimbursement by federal and state health programs and/or other payors, could impact the reimbursement we receive from Medicare programs and Medicaid health plans, the reimbursement we receive from PBM clients and other payors and/or our ability to negotiate rebates with pharmaceutical manufacturers, acquisition discounts with wholesalers and retail discounts with network pharmacies. The effect of these possible changes on our business cannot be predicted at this time.
During the past several years, the United States health care industry has been subject to an increase in governmental regulation, licensing, and audits at both the federal and state levels. Efforts to
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control health care costs, including prescription drug costs, are continuing at the federal and state government levels. Changing political, economic and regulatory influences may significantly affect health care financing and reimbursement practices. A change in the composition of pharmacy prescription volume toward programs offering lower reimbursement rates could negatively impact our profitability. Additionally, the results of the November 2016 elections have generated uncertainty with respect to, and could result in, significant changes in legislation, regulation and government policy that could significantly impact our business and the health care and retail industries. While it is not possible to predict whether and when any such changes will occur or what form any such changes may take, specific proposals discussed during and after the election that could have a material adverse effect on our business include, but are not limited to, the repeal of all or part of the Patient Protection and Affordable Care Act (the "Patient Care Act") and other significant changes to health care system legislation as well as changes with respect to tax and trade policies, tariffs and other government regulations affecting trade between the United States and other countries.
The repeal of all or part of the Patient Care Act, significant changes to Medicaid funding or even significant destabilization of the Health Insurance Marketplaces could impact the number of Americans with health insurance and, consequently, prescription drug coverage. Even if the Patient Care Act remains, significant provisions of the Patient Care Act have not yet been finalized (e.g., nondiscrimination in health programs and activities, excise tax on high-cost employer-sponsored health coverage) and it is uncertain whether or in what form these provisions will be finalized. We cannot predict the effect, if any, a repeal of all or part of the Patient Care Act, the implementation or failure to implement the outstanding provisions of the Patient Care Act, or the enactment of new health care system legislation to replace current legislation may have on our retail pharmacy, LTC pharmacy and pharmacy services operations.
A substantial portion of our pharmacy revenue is currently generated from a limited number of third party payors, and, if there is a loss of, or significant change to prescription drug reimbursement rates by, a major third party payor, our revenue will decrease and our business and prospects could be adversely impacted.
A substantial portion of our pharmacy revenue is currently generated from a limited number of third party payors. While we are not limited in the number of third party payors with which we can do business and results may vary over time, our top five third party payors accounted for 75.6%, 70.4%, and 69.7% of our pharmacy revenue during fiscal 2017, 2016 and 2015, respectively. The largest third party payor, Caremark, represented 27.3%, of pharmacy sales during fiscal 2017. The largest third party payor during fiscal 2016 and 2015, Express Scripts, represented 25.3% and 27.8% of fiscal 2016 and 2015 pharmacy sales, respectively. We expect that a limited number of third party payors will continue to account for a significant percentage of our pharmacy revenue, and the loss of, or a significant change to the prescription drug reimbursement rates by, a major third party payor could decrease our revenue and harm our business.
We are subject to governmental regulations, procedures and requirements; our noncompliance or a significant regulatory change could adversely affect our business, the results of our operations or our financial condition.
Our business is subject to numerous federal, state and local laws and regulations. Changes in these regulations may require extensive system and operating changes that may be difficult to implement. Untimely compliance or noncompliance with applicable regulations could result in the imposition of civil and criminal penalties that could adversely affect the continued operation of our business, including: (i) suspension of payments from government programs; (ii) loss of required government certifications; (iii) loss of authorizations to participate in or exclusion from government reimbursement programs, such as the Medicare and Medicaid programs; (iv) loss of licenses; or (v) significant fines or monetary penalties. The regulations to which we are subject include, but are not limited to, federal, state and local registration and regulation of pharmacies; dispensing and sale of controlled substances
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and products containing pseudoephedrine; applicable Medicare and Medicaid Regulations; the Health Insurance Portability and Accountability Act or ("HIPAA"); regulations relating to the protection of the environment and health and safety matters, including those governing exposure to and the management and disposal of hazardous substances; regulations enforced by the U. S. Federal Trade Commission, the U. S. Department of Health and Human Services and the Drug Enforcement Administration as well as state regulatory authorities, governing the sale, advertisement and promotion of products we sell; anti-kickback laws; false claims laws and federal and state laws governing the practice of the profession of pharmacy. We are also governed by federal and state laws of general applicability, including laws regulating matters of wage and hour laws, working conditions, health and safety and equal employment opportunity.
Additionally, Congress passed the Patient Care Act in 2010, which is resulting in significant structural changes to the health insurance system. Although many of the structural changes enacted by Patient Care Act were implemented in 2014, some of the applicable regulations and sub-regulatory guidance have not yet been issued and/or finalized (e.g., nondiscrimination in health programs and activities, excise tax on high cost employer sponsored coverage). The results of the November 2016 elections have generated uncertainty with respect to, and could result in, significant changes in legislation, regulation and government policy, including, but not limited to, the repeal of all or part of the Patient Care Act. Therefore, we cannot predict what effect, if any, the repeal of all or part of the Patient Care Act or any subsequent replacement legislation may have on our retail pharmacy and pharmacy services businesses.
Certain risks are inherent in providing pharmacy services; our insurance may not be adequate to cover any claims against us.
Pharmacies are exposed to risks inherent in the packaging and distribution of pharmaceuticals and other healthcare products, such as with respect to improper filling of prescriptions, labeling of prescriptions, adequacy of warnings, unintentional distribution of counterfeit drugs and expiration of drugs. In addition, federal and state laws that require our pharmacists to offer counseling, without additional charge, to their customers about medication, dosage, delivery systems, common side effects and other information the pharmacists deem significant can impact our business. Our pharmacists may also have a duty to warn customers regarding any potential negative effects of a prescription drug if the warning could reduce or negate these effects. Although we maintain professional liability and errors and omissions liability insurance, from time to time, claims result in the payment of significant amounts, some portions of which are not funded by insurance. We cannot assure you that the coverage limits under our insurance programs will be adequate to protect us against future claims, or that we will be able to maintain this insurance on acceptable terms in the future. Our results of operations, financial condition or cash flows may be adversely affected if in the future our insurance coverage proves to be inadequate or unavailable or there is an increase in liability for which we self-insure or we suffer reputational harm as a result of an error or omission.
We may be subject to significant liability should the consumption of any of our products cause injury, illness or death.
Products that we sell could become subject to contamination, product tampering, mislabeling or other damage requiring us to recall our products. In addition, errors in the dispensing and packaging of pharmaceuticals could lead to serious injury or death. Product liability claims may be asserted against us with respect to any of the products or pharmaceuticals we sell and we may be obligated to recall our products. A product liability judgment against us or a product recall could have a material, adverse effect on our business, financial condition or results of operations.
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Risks of declining gross margins in the PBM industry could adversely impact our profitability.
The PBM industry has been experiencing margin pressure as a result of competitive pressures and increased client demands for lower prices, enhanced service offerings and/or better service levels, and higher rebate yields. With respect to rebate yields, we maintain contractual relationships with brand name pharmaceutical manufacturers that provide for rebates on drugs dispensed by pharmacies in our retail network and by our mail order pharmacy (all or a portion of which may be passed on to clients). Manufacturer rebates often depend on a PBM's ability to meet contractual market share or other requirements, including in some cases the placement of a manufacturer's products on the PBM's formularies. If we lose our relationship with one or more pharmaceutical manufacturers, or if the rebates provided by pharmaceutical manufacturers decline, our business and financial results could be adversely affected. Further, changes in existing federal or state laws or regulations or the adoption of new laws or regulations relating to patent term extensions, rebate arrangements with pharmaceutical manufacturers, or to formulary management or other PBM services could also reduce the manufacturer rebates we receive.
We also maintain contractual relationships with participating pharmacies that provide for discounts on retail transactions for generic drugs and brand drugs dispensed by pharmacies in our retail network. If we lose our relationship with one or more of the larger pharmacies in our network, or if the retail discounts provided by network pharmacies decline, our business and financial results could be adversely affected. In addition, changes in federal or state laws or regulations or the adoption of new laws or regulations relating to claims processing and billing, including our ability to collect network administration and technology fees, could adversely impact our profitability.
The possibility of PBM client loss and/or the failure to win new PBM business could impact our ability to secure new business.
Our PBM business generates net revenues primarily by contracting with clients to provide prescription drugs and related health care services to plan members. PBM client contracts often have terms of approximately three years in duration, so approximately one third of a PBM's client base typically is subject to renewal each year. In some cases, however, PBM clients may negotiate a shorter or longer contract term or may require early or periodic renegotiation of pricing prior to expiration of a contract. In addition, the reputational impact of a service-related incident could negatively affect our ability to grow and retain our client base. Further, the PBM industry has been impacted by consolidation activity that may continue in the future. In the event one or more of our PBM clients is acquired by an entity that obtains PBM services from a competitor, we may be unable to retain all or a portion of our clients' business. Because of the competitive nature of the business, we continually face challenges in competing for new PBM business and retaining or renewing our existing PBM business. There can be no assurance that we will be able to win new business or secure renewal business on terms as favorable to us as the present terms. These circumstances, either individually or in the aggregate, could result in an adverse effect on our business and financial results.
Regulatory or business changes relating to our participation in Medicare Part D, the loss of Medicare Part D eligible members, or our failure to otherwise execute on our strategies related to Medicare Part D, may adversely impact our business and our financial results.
One of our subsidiaries, Envision Insurance Company ("EIC"), is an insurer domiciled in Ohio (with Ohio as its primary insurance regulator) and licensed in all 50 states, and is approved to function as a Medicare Part D Prescription Drug Plan ("PDP") plan sponsor for purposes of individual insurance products offered to Medicare-eligible beneficiaries and for purposes of making employer/union-only group waiver plans available for eligible clients. We also provide other products and services in support of our clients' Medicare Part D plans or the Federal Retiree Drug Subsidy program. We have made, and may be required to make further, substantial investments in the personnel and
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technology necessary to administer our Medicare Part D strategy. There are many uncertainties about the financial and regulatory risks of participating in the Medicare Part D program and we can give no assurance that these risks will not materially adversely impact our business and financial results in future periods.
EIC is subject to various contractual and regulatory compliance requirements associated with participating in Medicare Part D. EIC is subject to certain aspects of state laws regulating the business of insurance in all jurisdictions in which EIC offers its PDP plans. As a PDP sponsor, EIC is required to comply with Federal Medicare Part D laws and regulations applicable to PDP sponsors. Additionally, the receipt of Federal funds made available through the Part D program by us, our affiliates, or clients is subject to compliance with the Part D regulations and established laws and regulations governing the Federal government's payment for healthcare goods and services, including the Anti-Kickback Statute and the False Claims Act. Similar to our requirements with other clients, our policies and practices associated with operating our PDP are subject to audit. If material contractual or regulatory non-compliance was to be identified, monetary penalties and/or applicable sanctions, including suspension of enrollment and marketing or debarment from participation in Medicare programs, could be imposed. Further, the adoption or promulgation of new or more complex regulatory requirements associated with Medicare may require us to incur significant compliance-related costs which could adversely impact our business and our financial results.
In addition, due to the availability of Medicare Part D, some of our employer clients may decide to stop providing pharmacy benefit coverage to retirees, instead allowing the retirees to choose their own Part D plans, which could cause a reduction in demand for our Medicare Part D group insurance products. Extensive competition among Medicare Part D plans could also result in the loss of Medicare Part D members by our managed care customers, which would also result in a decline in our membership base. For example, if we were to lose our current Star rating with the Centers of Medicare and Medicaid Services, fewer customers may select our plans, which could have an adverse effect on our financial results. Like many aspects of our business, the administration of the Medicare Part D program is complex. Any failure to execute the provisions of the Medicare Part D program may have an adverse effect on our financial position, results of operations or cash flows. As discussed above, in March 2010, comprehensive healthcare reform was enacted into federal law through the passage of the Patient Care Act. Additionally, as described above, the Patient Care Act contains various changes to the Part D program and could have a financial impact on our PDP and our clients' demand for our other Part D products and services. Further, it is unclear what effect, if any, the repeal of all or part of the Patient Care Act may have on the Part D program.
Failure to timely identify or effectively respond to changing consumer preferences and spending patterns, an inability to expand the products being purchased by our clients and customers, or the failure or inability to obtain or offer particular categories of products could negatively affect our relationship with our clients and customers and the demand for our products and services.
The success of our business depends in part on customer loyalty, superior customer service and our ability to persuade customers to purchase products in additional categories and our private label brands. Failure to timely identify or effectively respond to changing consumer preferences and spending patterns, an inability to expand the products being purchased by our clients and customers, or the failure or inability to obtain or offer particular categories of products could negatively affect our relationship with our clients and customers and the demand for our products and services.
We offer our customers private label brand products that are available exclusively at our stores and through our online retail sites. The sale of private label products subjects us to unique risks including potential product liability risks and mandatory or voluntary product recalls, our ability to successfully protect our intellectual property rights and the rights of applicable third parties, and other risks generally encountered by entities that source, market and sell private-label products. Any failure to
25
adequately address some or all of these risks could have an adverse effect on our business, results of operations and financial condition. Additionally, an increase in the sales of our private label brands may negatively affect our sales of products owned by our suppliers which, consequently, could adversely impact certain of our supplier relationships. Our ability to locate qualified, economically stable suppliers who satisfy our requirements, and to acquire sufficient products in a timely and effective manner, is critical to ensuring, among other things, that customer confidence is not diminished. Any failure to develop sourcing relationships with a broad and deep supplier base could adversely affect our financial performance and erode customer loyalty.
Moreover, customer expectations and new technology advances from our competitors have required that our business evolve so that we are able to interface with our retail customers not only face-to-face in our stores but also online and via mobile and social media. Our customers are using computers, tablets, mobile phones and other electronic devices to shop in our stores and online, as well as to provide public reactions concerning each facet of our operation. If we fail to keep pace with dynamic customer expectations and new technology developments, our ability to compete and maintain customer loyalty could be adversely affected.
Finally, EnvisionRx's specialty pharmacy business focuses on complex and high-cost medications that serve a relatively limited universe of patients. As a result, the future growth of our specialty pharmacy business is dependent largely upon expanding our base of drugs or penetration in certain treatment categories. Any contraction of our base of patients or reduction in demand for the prescriptions we currently dispense could have an adverse effect on our business, financial condition and results of operations.
Risks Related to the Proposed WBA Merger and the Sale
The Merger with WBA and the Sale are subject to closing conditions, including governmental and regulatory approvals as well as other uncertainties and there can be no assurances as to whether and when the Merger and the Sale may be completed. Failure to complete the Merger or Sale could negatively impact our stock price, future business and financial results and could result in significant changes to our strategy.
There can be no assurance that the proposed Merger with WBA or the Sale will occur. Completion of the Merger is subject to certain conditions, including, among others, (i) receipt of the requisite vote of Rite Aid's stockholders approving the Merger Agreement; (ii) the absence of any order or law prohibiting the Merger; (iii) the expiration or earlier termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended; (iv) the accuracy of the parties' respective representations and warranties, subject in some instances to materiality or "Material Adverse Effect" qualifiers, as of the date of the Merger Agreement and the closing date of the Merger; (v) the parties' respective performance in all material respects (or, with respect to Rite Aid's specified obligations relating to incurring indebtedness, in all respects) of their respective agreements and covenants contained in the Merger Agreement at or prior to the closing of the Merger; and (vi) the absence of a "Material Adverse Effect" with respect to us, since the execution of the Amendment and as defined in the Merger Agreement, including the absence of any event, development, circumstance, change, effect, condition or occurrence that results in, as of the earlier of the End Date (as such term is defined in the Merger Agreement) and closing, Rite Aid failing to satisfy the EBITDA threshold set forth in the Merger Agreement (the "EBITDA test"). Similarly, completion of the Sale is subject to various closing conditions, including but not limited to (i) the closing of the Rite Aid Acquisition, (ii) the FTC having issued publicly the proposed final judgment relating to the Acquired Stores in connection with the Rite Aid Acquisition identifying Buyer as being preliminarily approved as the purchaser of the assets purchased under the Asset Purchase Agreement, (iii) filings with or receipt of approval from the applicable state boards of pharmacy, and (iv) the absence of a material adverse effect on the stores being acquired in the Sale. There can be no assurance that the requisite regulatory approvals will be obtained, that the other closing conditions will be satisfied, or that the Merger and/or
26
the Sale will be completed within the required time period pursuant to the Merger Agreement and Asset Purchase Agreement, as applicable. Satisfaction of the closing conditions may delay the completion of the Merger and the Sale, and if certain closing conditions are not satisfied prior to the End Date specified in the Merger Agreement or in the Asset Purchase Agreement, as applicable, the parties will not be obligated to complete the Merger or the Sale, as applicable. There also can be no assurance that, even if the Merger is completed, the per share merger consideration will exceed $6.50 per share. While the exact per share merger consideration is not known as of the date of this report, based on discussions with the FTC regarding potential remedies after filing the preliminary proxy statement, if the Merger is completed, Rite Aid believes that the per share merger consideration would likely be $6.50 per share.
If the Merger or Sale is not completed for any reason, we will have incurred substantial expenses. We have incurred substantial legal, accounting and financial advisory fees that are payable by us whether or not the Merger or Sale is completed, and our management has devoted considerable time and effort in connection with the pending Merger and Sale. If the Merger Agreement is terminated under certain limited circumstances, the Merger Agreement may require us to pay WBA a termination fee of $325 million. In addition, the trading price of our common stock could be adversely affected to the extent that the current price reflects an assumption that the Merger and the Sale will be completed. Additionally, there may be changes to our strategy in the event that the Merger or Sale do not close, which may include delaying or reducing capital or other expenditures, selling assets or other operations, closing underperforming stores, attempting to restructure or refinance our debt, seeking additional capital or incurring other costs associated with restructuring our business. Any of these event could cause us to incur significant charges. For these and other reasons, a failed Merger or Sale could materially adversely affect our business, operating results or financial condition.
The pendency of the Merger and the Sale may cause disruptions in our business, which could have an adverse effect on our business, financial condition or results of operations.
The pendency of the Merger and the Sale could cause disruptions in and create uncertainty regarding our business, which could have an adverse effect on our financial condition and results of operations, regardless of whether the Merger and the Sale are completed. These risks, which could be exacerbated by a delay in the completion of the Merger and the Sale, include the following:
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acceptable to us will be offered or that our business, prospects or results of operations will not be adversely affected;
Item 1B. Unresolved SEC Staff Comments
None
As of March 4, 2017, we operated 4,536 retail drugstores. The average selling square feet of each store in our chain is approximately 9,900 square feet. The average total square feet of each store in our chain is approximately 12,700. The stores in the eastern part of the U.S. average 8,900 selling square feet per store (11,200 average total square feet per store). The stores in the western part of the U.S. average 14,400 selling square feet per store (19,100 average total square feet per store).
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The table below identifies the number of stores by state as of March 4, 2017:
State
|
Store Count | |||
---|---|---|---|---|
Alabama |
93 | |||
California |
582 | |||
Colorado |
20 | |||
Connecticut |
77 | |||
Delaware |
42 | |||
District of Columbia |
7 | |||
Georgia |
176 | |||
Idaho |
14 | |||
Indiana |
10 | |||
Kentucky |
116 | |||
Louisiana |
55 | |||
Massachusetts |
146 | |||
Maine |
79 | |||
Maryland |
140 | |||
Michigan |
274 | |||
Mississippi |
26 | |||
North Carolina |
224 | |||
Nevada |
1 | |||
New Hampshire |
68 | |||
New Jersey |
251 | |||
New York |
599 | |||
Ohio |
224 | |||
Oregon |
73 | |||
Pennsylvania |
538 | |||
Rhode Island |
43 | |||
South Carolina |
89 | |||
Tennessee |
81 | |||
Utah |
22 | |||
Vermont |
37 | |||
Virginia |
187 | |||
Washington |
139 | |||
West Virginia |
103 | |||
| | | | |
Total |
4,536 | |||
| | | | |
| | | | |
| | | | |
Our stores have the following attributes at March 4, 2017:
Attribute
|
Number | Percentage | |||||
---|---|---|---|---|---|---|---|
Freestanding |
2,834 | 62.5 | % | ||||
Drive through pharmacy |
2,532 | 55.8 | % | ||||
GNC stores within a Rite Aid store |
2,367 | 52.2 | % |
We lease 4,283 of our operating drugstore facilities under non-cancelable leases, many of which have original terms of 10 to 22 years. In addition to minimum rental payments, which are set at competitive market rates, certain leases require additional payments based on sales volume, as well as reimbursement for taxes, maintenance and insurance. Most of our leases contain renewal options, some of which involve rent increases. The remaining 253 drugstore facilities are owned.
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We own our corporate headquarters, which is located in a 213,000 square foot building at 30 Hunter Lane, Camp Hill, Pennsylvania 17011. We lease 558,000 square feet of space in various buildings near Harrisburg, Pennsylvania for document warehousing use and additional administrative personnel. We own additional buildings near Harrisburg, Pennsylvania which total 100,000 square feet and house our model store and additional administrative personnel.
We operate the following distribution centers and satellite distribution locations, which we own or lease as indicated:
Location
|
Owned or Leased |
Approximate Square Footage |
||||
---|---|---|---|---|---|---|
Poca, West Virginia |
Owned | 255,000 | ||||
Perryman, Maryland |
Owned | 885,000 | ||||
Perryman, Maryland(1) |
Leased | 262,000 | ||||
Pontiac, Michigan |
Owned | 325,000 | ||||
Woodland, California |
Owned | 513,000 | ||||
Woodland, California(1) |
Leased | 200,000 | ||||
Wilsonville, Oregon |
Leased | 547,000 | ||||
Lancaster, California |
Owned | 914,000 | ||||
Spartanburg, South Carolina |
Leased | 855,000 | ||||
Dayville, Connecticut |
Owned | 460,000 | ||||
Liverpool, New York |
Owned | 828,000 | ||||
Philadelphia, Pennsylvania |
Owned | 245,000 | ||||
Philadelphia, Pennsylvania(1) |
Leased | 415,000 |
The original terms of the leases for our distribution centers and satellite distribution locations range from 5 to 20 years. In addition to minimum rental payments, certain distribution centers require tax reimbursement, maintenance and insurance. Most leases contain renewal options, some of which involve rent increases. Although from time to time, we may be near capacity at some of our distribution facilities, particularly at our older facilities, we believe that the capacity of our facilities is adequate.
During fiscal 2017, our distribution center in Spartanburg, South Carolina (the "Southeast DC") began servicing stores. The Southeast DC lease agreement has an initial term of 15 years with subsequent renewal options. In addition to minimum rental payments, we are also required to reimburse the landlord for taxes, maintenance and insurance. We consolidated our Charlotte, North Carolina and Tuscaloosa, Alabama distribution centers into the Southeast DC during the current fiscal year. During fiscal 2018, we will begin consolidating our Poca, West Virginia distribution center into the Southeast DC. The new Southeast DC will service approximately 1,000 stores in the southeastern United States once all three distribution centers are consolidated.
We also own a 55,600 square foot ice cream manufacturing facility and lease a 32,000 square foot storage facility located in El Monte, California.
We lease approximately 20,100 square feet in 36 HEB grocery stores in Texas under a master lease agreement that contains various renewal options through 2024.
Our Pharmacy Services segment leases approximately 232,000 square feet of space in various buildings primarily in Twinsburg, Ohio for additional administrative personnel. In addition, we own approximately 53,000 square feet of space in North Canton, Ohio for our mail order and specialty drug facilities.
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On a regular basis and as part of our normal business, we evaluate store performance and may reduce in size, close or relocate a store if the store is redundant, underperforming or otherwise deemed unsuitable. We also evaluate strategic dispositions and acquisitions of facilities and prescription files. When we reduce in size, close or relocate a store or close distribution center facilities, we often continue to have leasing obligations or own the property. We attempt to sublease this space. As of March 4, 2017, we had 6,323,122 square feet of excess space, 3,288,290 square feet of which was subleased.
As of March 4, 2017, we were aware of ten (10) putative class action lawsuits that were filed by our purported stockholders, against us, our directors (the Individual Defendants, together with Rite Aid, the Rite Aid Defendants), WBA and Victoria Merger Sub Inc. ("Victoria") challenging the transactions contemplated by the Merger agreement. Eight (8) of these actions were filed in the Court of Chancery of the State of Delaware (Smukler v. Rite Aid Corp., et al., Hirschler v. Standley, et al., Catelli v. Rite Aid Corp., et al., Orr v. Rite Aid Corp., et al., DePietro v. Standley, et al., Abadi v. Rite Aid Corp., et al., Mortman v. Rite Aid Corp., et al., Sachs Investment Grp., et al v. Standley, et al.). One (1) action was filed in Pennsylvania in the Court of Common Pleas of Cumberland County (Wilson v. Rite Aid Corp., et al.). The complaints in these nine (9) actions alleged primarily that the Individual Defendants breached their fiduciary duties by, among other things, agreeing to an allegedly unfair and inadequate price, agreeing to deal protection devices that allegedly prevented the directors from obtaining higher offers from other interested buyers for Rite Aid and allegedly failing to protect against certain purported conflicts of interest in connection with the Merger. The complaints further alleged that we, WBA and/or Victoria aided and abetted these alleged breaches of fiduciary duty. The complaints sought, among other things, to enjoin the closing of the Merger as well as money damages and attorneys' and experts' fees.
On December 23, 2015, the eight (8) Delaware actions were consolidated in an action captioned In re Rite Aid Corporation Stockholders Litigation, Consol. C.A. No. 11663-CB (the "Consolidated Action"). In addition to the claims asserted in the nine (9) complaints discussed above, the operative pleading in the Consolidated Action also included allegations that the preliminary proxy statement contained material omissions, including with respect to the process that resulted in the Merger agreement and the fairness opinion rendered by our banker. On December 28, 2015, the plaintiffs in the Consolidated Action filed a motion for expedited proceedings, which the Court orally denied at a hearing held on January 5, 2016. On March 11, 2016, the Court granted the plaintiffs' notice and proposed order voluntarily dismissing the Consolidated Action as moot, while retaining jurisdiction solely for the purpose of adjudicating plaintiffs' counsel's anticipated application for an award of attorneys' fees and reimbursement of expenses. On April 15, 2016, we reached a settlement in principle related to this matter for an immaterial amount. On May 11, 2016, the Court entered a stipulated order regarding notice of payment thereof and final dismissal of this matter.
A tenth action was filed in the United States District Court for the Middle District of Pennsylvania (the "Pennsylvania District Court"), asserting a claim for violations of Section 14(a) of the Exchange Act and SEC Rule 14a-9 against the Rite Aid Defendants, WBA and Victoria and a claim for violations of Section 20(a) of the Exchange Act against the Individual Defendants and WBA (Herring v. Rite Aid Corp., et al.). The complaint in the Herring action alleges, among other things, that we and the Individual Defendants disseminated an allegedly false and materially misleading proxy. The complaint sought to enjoin the shareholder vote on the proposed Merger, a declaration that the proxy was materially false and misleading in violation of federal securities laws and an award of money damages and attorneys' and experts' fees. On January 14 and 16, 2016, respectively, the plaintiff in the Herring action filed a motion for preliminary injunction and a motion for expedited discovery. On January 21, 2016, the Rite Aid Defendants filed a motion to dismiss the Herring complaint. At a
31
hearing held on January 25, 2016, the Pennsylvania District Court orally denied the plaintiff's motion for expedited discovery and subsequently denied the plaintiff's motion for preliminary injunction on January 28, 2016. On March 14, 2016, the Pennsylvania District Court appointed Jerry Herring, Don Michael Hussey and Joanna Pauli Hussey as lead plaintiffs for the putative class and approved their selection of Robbins Geller Rudman & Dowd LLP as lead counsel. On April 14, 2016, the Pennsylvania District Court granted the lead plaintiffs' unopposed motion to stay the Herring action for all purposes pending consummation of the Merger.
We have been named in a collective and class action lawsuit, Indergit v. Rite Aid Corporation, et al., pending in the United States District Court for the Southern District of New York, filed purportedly on behalf of current and former store managers working in our stores at various locations around the country. The lawsuit alleges that we failed to pay overtime to store managers as required under the FLSA and under certain New York state statutes. The lawsuit also seeks other relief, including liquidated damages, attorneys' fees, costs and injunctive relief arising out of state and federal claims for overtime pay. On April 2, 2010, the Court conditionally certified a nationwide collective group of individuals who worked for the us as store managers since March 31, 2007. The Court ordered that Notice of the Indergit action be sent to the purported members of the collective group (approximately 7,000 current and former store managers) and approximately 1,550 joined the Indergit action. Discovery as to certification issues has been completed. On September 26, 2013, the Court granted Rule 23 class certification of the New York store manager claims as to liability only, but denied it as to damages, and denied our motion for decertification of the nationwide collective action claims. We filed a motion seeking reconsideration of the Court's September 26, 2013 decision which motion was denied in June 2014. We subsequently filed a petition for an interlocutory appeal of the Court's September 26, 2013 ruling with the U. S. Court of Appeals for the Second Circuit which petition was denied in September 2014. Notice of the Rule 23 class certification as to liability only has been sent to approximately 1,750 current and former store managers in the state of New York. Discovery related to the merits of the claims is ongoing. On January 12, 2017, the parties reached a settlement in principle of this matter, for an immaterial amount of money, which is subject to preliminary and final approval by the court. On January 19, 2017, the court entered an order staying the case indefinitely pending preliminary and final court approval. In the event the settlement does not receive preliminary and/or final approval by the court, the litigation will resume. If such occurs, we presently are not able to either predict the outcome of this lawsuit or estimate a potential range of loss with respect to the lawsuit. Our management believes, however, that this lawsuit is without merit and is vigorously defending this lawsuit.
We are currently a defendant in several lawsuits filed in state courts in California alleging violations of California wage-and-hour laws, rules and regulations pertaining primarily to failure to pay overtime, failure to pay for missed meals and rest periods, failure to reimburse business expenses and failure to provide employee seating (the "California Cases"). The class actions pertaining to failure to reimburse business expenses and provide employee seating purport to be class actions and seek substantial damages. The single-plaintiff and multi-plaintiff lawsuits regarding failure to pay overtime and failure to pay for missed meals and rest periods, in the aggregate, seek substantial damages. We have aggressively challenged the merits of the lawsuits and, where applicable, the allegations that the cases should be certified as class or representative actions.
In the business expense class action (Fenley v. Rite Aid Corporation, Santa Clara Superior Court), the parties reached a settlement pursuant to which we will pay an immaterial amount to settle the class claims. The court granted final approval of the settlement on February 3, 2017.
In the employee seating case (Hall v. Rite Aid Corporation, San Diego County Superior Court), the Court, in October 2011, granted the plaintiff's motion for class certification. We filed our motion for decertification, which motion was granted in November 2012. Plaintiff subsequently appealed the Court's order which appeal was granted in May 2014. We filed a petition for review of the appellate court's decision with the California Supreme Court, which petition was denied in August 2014.
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Proceedings in the Hall case were stayed pending a decision by the California Supreme Court in two similar cases. That decision was rendered on April 4, 2016. A status conference in the case was held on November 18, 2016, at which time the court lifted the stay and scheduled the case for trial on January 26, 2018.
With respect to the California Cases, we, at this time, are not able to predict either the outcome of these lawsuits or estimate a potential range of loss with respect to said lawsuits and is vigorously defending them.
We were served with a Civil Investigative Demand Subpoena Duces Tecum dated August 26, 2011 by the United States Attorney's Office for the Eastern District of Michigan. The subpoena requests records regarding the relationship of Rite Aid's Rx Savings Program to the reporting of usual and customary charges to publicly funded health programs. In connection with the same investigation, we were served with a Civil Subpoena Duces Tecum dated February 22, 2013 by the State of Indiana Office of the Attorney General requesting additional information regarding both Rite Aid's Rx Savings Program and usual and customary charges. We responded to both of the subpoenas. To enable the parties to discuss a possible resolution, the Medicaid Fraud Control Units of the several states, commonwealths, and the District of Columbia and Rite Aid entered into an agreement tolling the statute of limitations until October 7, 2015. The parties agreed to extend the tolling agreement and continue to exchange pertinent claims data in the near future. On January 19, 2017, the District Court for the Eastern District of Michigan unsealed Relator's Second Amended Complaint against us. In its Complaint, Relator alleges that we failed to report Rx Savings prices as its usual and customary charges under the Medicare Part D program and to federal and state Medicaid programs in 18 (eighteen) states and the District of Columbia; and that we are thus liable under the federal False Claims Act and similar False Claims Act statutes operative in the states named in the Complaint. The federal government and the 18 (eighteen) states and the District of Columbia named in the lawsuit have elected not to intervene in this action. At this stage of the proceedings, we are not able to either predict the outcome of this lawsuit or estimate a potential range of loss with respect to the lawsuit and is vigorously defending this lawsuit.
On April 26, 2012, we received an administrative subpoena from the U.S. Drug Enforcement Administration ("DEA"), Albany, New York District Office, requesting information regarding our sale of products containing pseudoephedrine ("PSE"). In April 2012, we also received a communication from the U.S. Attorney's Office ("USAO") for the Northern District of New York concerning an investigation of possible civil violations of the Combat Methamphetamine Epidemic Act of 2005 ("CMEA"). Additional subpoenas were issued in 2013, 2014, and 2015 seeking broader documentation regarding PSE sales and recordkeeping requirements. Assistant U.S. Attorneys from the Northern and Eastern Districts of New York and the Southern District of West Virginia are currently investigating, but no lawsuits or charges have been filed. Between September 2015 and January 2017, we received several grand jury subpoenas from the U.S. District Court for the Southern District of West Virginia seeking additional information in connection with the investigation of violations of the CMEA and/or the Controlled Substances Act ("CSA"). Violations of the CMEA or the CSA could result in the imposition of administrative, civil and/or criminal penalties against us. We are cooperating with the government and continue to provide information responsive to the subpoenas. We have entered into a tolling agreement with the USAOs in the Northern and Eastern Districts of New York and entered into a separate tolling agreement with the USAO in the Southern District of West Virginia. Discussions are underway to attempt to resolve these matters with those USAOs and the Department of Justice, but whether an agreement can be reached and on what terms is uncertain. While our management cannot predict the outcome of these matters, it is possible that our results of operations or cash flows could be materially affected by an unfavorable resolution. At this stage of the investigation, we are not able to predict the outcome of the investigation.
33
In January 2013, the DEA, Los Angeles District Office, served an administrative subpoena on us seeking documents related to prescriptions by a certain prescriber. The USAO, Central District of California, also contacted us about a related investigation into allegations that our pharmacies filled certain controlled substance prescriptions for a number of prescribers after their DEA registrations had expired or otherwise become invalid in violation of the federal Controlled Substances Act and DEA regulations. We responded to the administrative subpoena and subsequent informal requests for information from the USAO. We met with the USAO and DEA in January 2014 regarding this matter. We entered into a tolling agreement with the USAO. We recorded a legal accrual during the period ended March 1, 2014, which was revised during the period ending August 29, 2015. On February 28, 2017, the USAO, Central District of California, and Rite Aid entered into a settlement agreement resolving this matter for an immaterial amount. The settlement agreement is not an admission of liability by us.
In June 2013, we were served with a Civil Investigative Demand ("CID") by the United States Attorney's Office for the Eastern District of California (the "USAO"). The CID requested records and responses to interrogatories regarding our Drug Utilization Review and prescription dispensing protocol and the dispensing of drugs designated as "Code 1" by the State of California. We researched the government's allegations and refuted the government's position in writing and on conference calls. Subsequently, the USAO's office, along with the State of California, Department of Justice, Bureau of Medical Fraud and Elder Abuse (the "Bureau"), requested we produce certain prescription files related to Code 1 drugs. There has been a series of four document productions in which we have produced prescription and associated documentation concerning Code 1 drugs: (i) on May 15, 2014, the government requested that we produce 60 prescriptions; (ii) on July 30, 2014, the government requested that we produce 30 prescriptions; (iii) on June 15, 2015, the government requested that we produce 80 prescriptions; and (iv) on September 30, 2016, we agreed to produce an additional 242 prescriptions. We are continuing discussions with the government.
Relator, Matthew Omlansky, filed a qui tam action, State of California ex rel. Matthew Omlansky v. Rite Aid Corporation, on behalf of the State of California against Rite Aid in the Superior Court of the State of California. In his Complaint, Relator alleges that we violated the California False Claims Act by (i) failing to comply with California rules governing our reporting of our usual and customary prices; (ii) failing to dispense the least expensive equivalent generic drug in certain circumstances, in violation of applicable regulations; and (iii) dispensing, and seeking reimbursement for, restricted brand name drugs without prior approval. Relator filed his Second Amended Complaint on April 19, 2016 and we filed our demurrer on July 29, 2016. On October 5, 2016, our demurrer was granted and plaintiff's complaint was dismissed with leave for plaintiff to file an amended complaint. Plaintiff filed a Third Amended Complaint to which we filed a second demurrer, which is pending. At this stage of the proceedings, we are unable to predict the outcome of its demurrer and Relator's suit.
In addition to the above described matters, we are subject from time to time to various claims and lawsuits and governmental investigations arising in the ordinary course of business. While the our management cannot predict the outcome of any of the claims, our management does not believe that the outcome of any of these legal matters will be material to our consolidated financial position. It is possible, however, that our results of operations or cash flows could be materially affected by an unfavorable resolution of pending litigation or contingencies.
Item 4. Mine Safety Disclosures
Not applicable
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Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock is listed on the NYSE under the symbol "RAD." On April 17, 2017, we had approximately 18,240 stockholders of record. Quarterly high and low closing stock prices, based on the composite transactions, are shown below.
Fiscal Year
|
Quarter | High | Low | ||||||
---|---|---|---|---|---|---|---|---|---|
2018 (through April 17, 2017) |
First | $ | 5.23 | $ | 4.19 | ||||
2017 |
First | 8.19 | 7.63 | ||||||
|
Second | 7.84 | 6.82 | ||||||
|
Third | 8.21 | 6.43 | ||||||
|
Fourth | 8.70 | 5.25 | ||||||
2016 |
First | 8.87 | 7.31 | ||||||
|
Second | 9.32 | 7.75 | ||||||
|
Third | 8.67 | 6.05 | ||||||
|
Fourth | 7.96 | 7.58 |
We have not declared or paid any cash dividends on our common stock since the third quarter of fiscal 2000 and we do not anticipate paying cash dividends on our common stock in the foreseeable future. Our senior secured credit facility, second priority secured term loan facilities and some of the indentures that govern our other outstanding indebtedness restrict our ability to pay dividends.
We have not sold any unregistered equity securities during the period covered by this report, nor have we repurchased any of our common stock, during the period covered by this report.
Pursuant to the terms of the acquisition agreement, we issued approximately 27.8 million shares of common stock in connection with the June 24, 2015 acquisition of EnvisionRx.
The graph below compares the yearly percentage change in the cumulative total stockholder return on our common stock for the last five fiscal years with the cumulative total return on (i) the Russell 1000 Consumer Staples Index, and (ii) the Russell 1000 Index, over the same period (assuming the investment of $100.00 in our common stock and such indexes on March 3, 2012 and reinvestment of dividends).
For comparison of cumulative total return, we have elected to use the Russell 1000 Consumer Staples Index, consisting of 55 companies including the three largest drugstore chains, and the Russell 1000 Index. This allows comparison of the company to a peer group of similar sized companies. We are one of the companies included in the Russell 1000 Consumer Staples Index and the Russell 1000 Index. The Russell 1000 Consumer Staples Index is a capitalization-weighted index of companies that provide products directly to consumers that are typically considered nondiscretionary items based on consumer purchasing habits. The Russell 1000 Index consists of the largest 1000 companies in the Russell 3000 Index and represents the universe of large capitalization stocks from which many active money managers typically select.
35
STOCK PERFORMANCE GRAPH
Comparison of 5 Year Cumulative Total Return
Assumes Initial Investment of $100 on March 3, 2012
March 4, 2017
|
2013 | 2014 | 2015 | 2016 | 2017 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
RITE AID CORP |
100.60 | 394.61 | 477.84 | 476.65 | 326.35 | |||||||||||
Russell 1000 Index |
113.50 | 143.12 | 164.42 | 153.71 | 193.07 | |||||||||||
Russell 1000 Consumer Staples Index |
117.87 | 135.23 | 165.26 | 174.50 | 195.03 |
36
Item 6. Selected Financial Data
The following selected financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the audited consolidated financial statements and related notes.
|
Fiscal Year Ended | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
March 4, 2017 (53 weeks)(*) |
February 27, 2016 (52 weeks)(*) |
February 28, 2015 (52 weeks) |
March 1, 2014 (52 weeks) |
March 2, 2013 (52 weeks) |
|||||||||||
|
(Dollars in thousands, except per share amounts) |
|||||||||||||||
Summary of Operations: |
||||||||||||||||
Revenues |
$ | 32,845,073 | $ | 30,736,657 | $ | 26,528,377 | $ | 25,526,413 | $ | 25,392,263 | ||||||
Costs and expense: |
||||||||||||||||
Cost of revenues |
25,071,008 | 22,910,402 | 18,951,645 | 18,202,679 | 18,073,987 | |||||||||||
Selling, general and administrative expenses |
7,242,359 | 7,013,346 | 6,695,642 | 6,561,162 | 6,600,765 | |||||||||||
Lease termination and impairment charges |
55,294 | 48,423 | 41,945 | 41,304 | 70,859 | |||||||||||
Interest expense |
431,991 | 449,574 | 397,612 | 424,591 | 515,421 | |||||||||||
Loss on debt retirements, net |
| 33,205 | 18,512 | 62,443 | 140,502 | |||||||||||
(Gain) loss on sale of assets, net |
(4,024 | ) | 3,303 | (3,799 | ) | (15,984 | ) | (16,776 | ) | |||||||
| | | | | | | | | | | | | | | | |
Total costs and expenses |
32,796,628 | 30,458,253 | 26,101,557 | 25,276,195 | 25,384,758 | |||||||||||
| | | | | | | | | | | | | | | | |
Income before income taxes |
48,445 | 278,404 | 426,820 | 250,218 | 7,505 | |||||||||||
Income tax expense (benefit) |
44,392 | 112,939 | (1,682,353 | ) | 804 | (110,600 | ) | |||||||||
| | | | | | | | | | | | | | | | |
Net income |
$ | 4,053 | $ | 165,465 | $ | 2,109,173 | $ | 249,414 | $ | 118,105 | ||||||
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Basic and diluted income per share: |
||||||||||||||||
Basic income per share |
$ | 0.00 | $ | 0.16 | $ | 2.17 | $ | 0.23 | $ | 0.12 | ||||||
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Diluted income per share |
$ | 0.00 | $ | 0.16 | $ | 2.08 | $ | 0.23 | $ | 0.12 | ||||||
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Year-End Financial Position: |
||||||||||||||||
Working capital |
$ | 2,060,040 | $ | 1,553,832 | $ | 1,736,758 | $ | 1,777,673 | $ | 1,830,777 | ||||||
Property, plant and equipment, net |
2,251,692 | 2,255,398 | 2,091,369 | 1,957,329 | 1,895,650 | |||||||||||
Total assets(1) |
11,593,752 | 11,277,010 | 8,777,425 | 6,860,672 | 6,985,038 | |||||||||||
Total debt(1) |
7,328,693 | 6,994,136 | 5,559,116 | 5,672,944 | 5,939,850 | |||||||||||
Stockholders' equity (deficit) |
614,070 | 581,428 | 57,056 | (2,113,702 | ) | (2,459,434 | ) | |||||||||
Other Data: |
||||||||||||||||
Cash flows provided by (used in): |
||||||||||||||||
Operating activities |
225,863 | 997,402 | 648,959 | 702,046 | 819,588 | |||||||||||
Investing activities |
(464,259 | ) | (2,401,858 | ) | (593,685 | ) | (364,924 | ) | (346,305 | ) | ||||||
Financing activities |
359,335 | 1,413,028 | (85,781 | ) | (320,168 | ) | (506,116 | ) | ||||||||
Capital expenditures |
481,111 | 669,995 | 539,386 | 421,223 | 382,980 | |||||||||||
Basic weighted average shares |
1,044,427 | 1,024,377 | 971,102 | 922,199 | 889,562 | |||||||||||
Diluted weighted average shares |
1,060,826 | 1,042,362 | 1,017,861 | 979,092 | 907,259 | |||||||||||
Number of retail drugstores |
4,536 | 4,561 | 4,570 | 4,587 | 4,623 | |||||||||||
Number of associates |
88,000 | 90,000 | 89,000 | 89,000 | 89,000 |
37
As a result of the Acquisition, and the related addition of the Pharmacy Services segment, we now refer to our cost of goods sold as our cost of revenues, as these costs are now inclusive of the cost of prescription drugs sold through the Pharmacy Services segment's retail pharmacy network under contracts where it is the principal.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
We are a pharmacy retail healthcare company, providing our customers and communities with the highest level of care and service through various programs we offer through our two reportable business segments, our Retail Pharmacy segment and our Pharmacy Services segment. We accomplish our goal of delivering comprehensive care to our customers through our 4,536 retail drugstores, 99 RediClinic walk-in retail health clinics and transparent and traditional EnvisionRx and MedTrak pharmacy benefit managers with approximately 4.0 million plan members. We also offer fully integrated mail-order and specialty pharmacy services through EnvisionPharmacies. Additionally through EIC, EnvisionRx also serves one of the fastest-growing demographics in healthcare: seniors enrolled in Medicare Part D. When combined with our retail platform, this comprehensive suite of services allows us to provide value and choice to customers, patients and payors and allows us to succeed in today's evolving healthcare marketplace.
We have two reportable business segments: Retail Pharmacy segment and Pharmacy Services segment.
Retail Pharmacy Segment
Our Retail Pharmacy segment sells brand and generic prescription drugs, as well as an assortment of front-end products including health and beauty aids, personal care products, seasonal merchandise, and a large private brand product line. Our Retail Pharmacy segment generates the majority of its revenue through the sale of prescription drugs and front-end products at our 4,536 retail locations. In addition, the Retail Pharmacy segment includes 99 RediClinic walk-in retail clinics, of which 63 are located within Rite Aid retail stores in the Baltimore/Washington D.C, Philadelphia, Seattle and New Jersey markets.
Pharmacy Services Segment
Our Pharmacy Services segment, which was acquired on June 24, 2015 through our acquisition of EnvisionRx, provides a full range of pharmacy benefit services. The Pharmacy Services segment provides both transparent and traditional pharmacy benefit management ("PBM") options through its EnvisionRx and MedTrak PBMs, respectively. EnvisionRx also offers fully integrated mail-order and specialty pharmacy services through EnvisionPharmacies; access to the nation's largest cash pay infertility discount drug program via Design Rx; an innovative claims adjudication software platform in Laker Software; and a national Medicare Part D prescription drug plan through EIC's EnvisionRx Plus product offering. The segment's clients are primarily employers, insurance companies, unions, government employee groups, health plans, Managed Medicaid plans, Medicare plans, other sponsors of health benefit plans and individuals throughout the United States.
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Pending Merger with Walgreens Boots Alliance, Inc.
On October 27, 2015, we entered into the original Merger Agreement, which was subsequently amended by the Amendment on January 29, 2017. Pursuant to the terms and subject to the conditions set forth in the Merger Agreement, Victoria Merger Sub will merge with and into Rite Aid, with Rite Aid surviving the Merger as a 100 percent owned direct subsidiary of WBA. Completion of the Merger is subject to various closing conditions, including but not limited to (i) approval of the Merger Agreement by the holders of our common stock, (ii) the expiration or earlier termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, (iii) the absence of any law or order prohibiting the Merger, and (iv) the absence of a material adverse effect on us, as defined in the Merger Agreement. Under the terms of the Merger Agreement, at the effective time of the Merger, each share of our common stock, par value $1.00 per share, issued and outstanding immediately prior to the effective time (other than shares owned by (i) WBA, Victoria Merger Sub or us (which will be cancelled), (ii) stockholders who have properly exercised and perfected appraisal rights under Delaware law, or (iii) any direct or indirect 100 percent owned subsidiary of ours or WBA (which will be converted into shares of common stock of the surviving corporation)) will be converted into the right to receive a maximum of $7.00 in cash per share and a minimum of $6.50 in cash per share, without interest. The exact per share merger consideration will be determined based on the number of retail stores that WBA agrees to divest in connection with the parties' efforts to obtain the required regulatory approvals for the Merger, with the price set at $7.00 per share if 1,000 stores or fewer retail stores are required to be divested and at $6.50 per share if 1,200 retail stores are required to be divested (or more, if WBA agrees to sell more). If the required divestitures fall between 1,000 and 1,200 stores, then there will be a pro-rata adjustment of the price per share. While the exact per share merger consideration is not known as of the date of this report, based on discussions with the FTC regarding potential remedies after filing the preliminary proxy statement, if the Merger is completed, we believe that the per share merger consideration would likely be $6.50 per share.
We, WBA and Victoria Merger Sub have each made customary representations, warranties and covenants in the Merger Agreement, including, among other things, that (i) we and our subsidiaries will continue to conduct our business in the ordinary course consistent with past practice between the execution of the Merger Agreement and the closing of the Merger and (ii) we will not solicit proposals relating to alternative transactions to the Merger or engage in discussions or negotiations with respect thereto, subject to certain exceptions. Additionally, the Merger Agreement limits our ability to incur indebtedness for borrowed money and issue additional capital stock, among other things.
Pursuant to the Amendment, we and WBA extended the "End Date" (as defined in the Merger Agreement) to July 31, 2017.
On December 19, 2016, we entered into the Asset Purchase Agreement. Pursuant to the terms and subject to the conditions set forth in the Asset Purchase Agreement, Buyer agreed to purchase from Rite Aid the Acquired Stores and certain specified assets related thereto for a purchase price of $950.0 million plus Buyer's assumption of certain liabilities of ours and our affiliates.
Completion of the Sale is subject to various closing conditions, including but not limited to (i) the closing of the Rite Aid Acquisition, (ii) the FTC having issued publicly the proposed final judgment relating to the Acquired Stores in connection with the Rite Aid Acquisition identifying Buyer as being preliminarily approved as the purchaser of the assets purchased under the Asset Purchase Agreement, (iii) filings with or receipt of approval from the applicable state boards of pharmacy, and (iv) the absence of a material adverse effect on the stores being acquired in the Sale.
The parties to the Asset Purchase Agreement have each made customary representations and warranties. We have agreed to various covenants and agreements, including, among others, our agreement to conduct our business at the Acquired Stores in the ordinary course during the period between the execution of the Asset Purchase Agreement and the closing of the Sale, subject to certain
39
exceptions. Fred's and Buyer have also agreed to various covenants and agreements in the Asset Purchase Agreement, including, among other things, (i) Fred's and Buyer's agreement to use their reasonable best efforts to obtain all authorizations and approvals from governmental authorities and (ii) Fred's and Buyer's agreement to (x) prepare and furnish all necessary information and documents reasonably requested by the FTC, (y) use reasonable best efforts to demonstrate to the FTC that each of Fred's and Buyer is an acceptable purchaser of, and will compete effectively using, the assets purchased in the Sale, and (z) reasonably cooperate with WBA and us in obtaining all FTC approvals. In the event that the FTC requests changes to the Asset Purchase Agreement, the parties agreed to negotiate in good faith to make the necessary changes. To the extent the FTC requests that additional stores be sold, and WBA agrees to sell such stores, each of Fred's and Buyer has agreed to buy those stores.
The Asset Purchase Agreement contains specified termination rights for us, WBA and Buyer, including a mutual termination right (i) in the event of the issuance of a final, nonappealable governmental order permanently restraining the Sale or (ii) in the event that the Merger Agreement is terminated in accordance with its terms. WBA has additional termination rights, if, among others thing, (i) Buyer or Fred's is not preliminarily approved by the FTC or other necessary governmental authority as purchaser of the assets in the Sale or (ii) the FTC informs WBA or its affiliates in writing that the Director of the Bureau of Competition will not recommend approval of Fred's or Buyer as purchaser of the assets in the Sale.
Rite Aid expects that the Asset Purchase Agreement will be amended to, among other things, make certain changes contemplated by the Amendment.
While WBA and Rite Aid are actively engaged in discussions with the FTC regarding the transaction and are working towards a close of the Merger by July 31, 2017, there can be no assurance that the requisite regulatory approvals will be obtained, or that the Merger or the Sale will be completed within the time periods contemplated by the Merger Agreement and Asset Purchase Agreement on the current terms, if at all. In the event the Merger Agreement is terminated in certain circumstances involving a failure to obtain required regulatory approvals or if the Merger is not completed by July 31, 2017, WBA is required to pay us a $325 million termination fee; provided that such termination fee is reduced to $162.5 million if (i) on the termination date we fail to satisfy the EBITDA test or (ii) if WBA exercises its right to terminate the Merger Agreement as a result of our failure to satisfy the EBITDA test as of the End Date or as of the date on which closing is required to occur. Additionally, there may be changes to our strategy in the event that the Merger or Sale do not close, which may include delaying or reducing capital or other expenditures, selling assets or other operations, closing underperforming stores, attempting to restructure or refinance our debt, seeking additional capital, or incurring other costs associated with restructuring our business.
Overview of Financial Results
Net Income: Our net income for fiscal 2017 was $4.1 million or $0.00 per basic and diluted share compared to net income for fiscal 2016 of $165.5 million or $0.16 per basic and diluted share. The operating results for fiscal 2017 include the operating results of EnvisionRx. The operating results for fiscal 2016 include the operating results of EnvisionRx subsequent to the June 24, 2015 acquisition date. The decline in our operating results was driven primarily by a decline in Adjusted EBITDA and an increase in the Pharmacy Services segment amortization expense, partially offset by lower income tax expense, a $33.2 million loss on debt retirement in the prior year and lower interest expense.
Adjusted EBITDA: Our Adjusted EBITDA for fiscal 2017 was $1,137.1 million or 3.5 percent of revenues, compared to $1,402.3 million or 4.6 percent of revenues for fiscal year 2016. Adjusted EBITDA for fiscal 2017 includes the Adjusted EBITDA of EnvisionRx. Adjusted EBITDA for fiscal 2016 includes the Adjusted EBITDA of EnvisionRx subsequent to the June 24, 2015 acquisition date.
40
The decline in our Adjusted EBITDA was due primarily to a decrease of $352.0 million in the Retail Pharmacy segment, resulting from lower pharmacy gross profit due to lower reimbursement rates. The decline in the Retail Pharmacy segment Adjusted EBITDA was partially offset by an increase of $86.9 million of Pharmacy Services segment Adjusted EBITDA. This increase was due to strong operating results in the current year and the fact that prior year's Pharmacy Services segment results do not reflect a full year's ownership of EnvisionRx. Please see the sections entitled "Segment Analysis" and "Adjusted EBITDA, Adjusted Net Income, Adjusted Net Income per Diluted Share and Other Non-GAAP Measures" below for additional details.
Consolidated Results of Operations
Revenue and Other Operating Data
|
Year Ended | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
March 4, 2017 (53 Weeks) |
February 27, 2016 (52 Weeks) |
February 28, 2015 (52 Weeks) |
|||||||
|
(Dollars in thousands except per share amounts) |
|||||||||
Revenues(a) |
$ | 32,845,073 | $ | 30,736,657 | $ | 26,528,377 | ||||
Revenue growth |
6.9 | % | 15.9 | % | 3.9 | % | ||||
Net income |
$ | 4,053 | $ | 165,465 | $ | 2,109,173 | ||||
Net income per diluted share |
$ | 0.00 | $ | 0.16 | $ | 2.08 | ||||
Adjusted EBITDA(b) |
$ | 1,137,141 | $ | 1,402,262 | $ | 1,322,843 | ||||
Adjusted Net Income(b) |
$ | 66,817 | $ | 255,236 | $ | 273,044 | ||||
Adjusted Net Income per Diluted Share(b) |
$ | 0.06 | $ | 0.24 | $ | 0.27 |
Revenues
Fiscal 2017 compared to Fiscal 2016: The 6.9% increase in revenues was due primarily to the increase in the Pharmacy Services segment, due to a full year of Pharmacy Services segment operating result being included in the current year as compared to a partial year in the prior year, partially offset by decreases in the Retail Pharmacy segment. Revenues for fiscal 2017 exclude $365.5 million of inter-segment activity that is eliminated in consolidation. Same store sales trends for fiscal 2017 and fiscal 2016 are described in the "Segment Analysis" section below.
Fiscal 2016 compared to Fiscal 2015: The 15.9% increase in revenues were due primarily to the addition of the Pharmacy Services segment, which was acquired on June 24, 2015. Revenues for fiscal 2016 include revenues of $4,103.5 million relating to our Pharmacy Services segment and exclude $232.8 million of inter-segment activity that is eliminated in consolidation.
Please see the section entitled "Segment Analysis" below for additional details regarding revenues.
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Costs and Expenses
|
Year Ended | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
March 4, 2017 (53 Weeks) |
February 27, 2016 (52 Weeks) |
February 28, 2015 (52 Weeks) |
|||||||
|
(Dollars in thousands) |
|||||||||
Costs of revenues(a) |
$ | 25,071,008 | $ | 22,910,402 | $ | 18,951,645 | ||||
Gross profit |
7,774,065 | 7,826,255 | 7,576,732 | |||||||
Gross margin |
23.7 | % | 25.5 | % | 28.6 | % | ||||
Selling, general and administrative expenses |
$ | 7,242,359 | $ | 7,013,346 | $ | 6,695,642 | ||||
Selling, general and administrative expenses as a percentage of revenues |
22.1 | % | 22.8 | % | 25.2 | % | ||||
Lease termination and impairment charges |
55,294 | 48,423 | 41,945 | |||||||
Interest expense |
431,991 | 449,574 | 397,612 | |||||||
Loss on debt retirements, net |
| 33,205 | 18,512 | |||||||
(Gain) loss on sale of assets, net |
(4,024 | ) | 3,303 | (3,799 | ) |
Gross Profit and Cost of Revenues
Gross profit decreased by $52.2 million in fiscal 2017 compared to fiscal 2016. Gross profit for fiscal 2017 includes incremental gross profit of $161.9 million relating to our Pharmacy Services segment due to a full year of Pharmacy Services segment operating results being included in the current year as compared to a partial year in the prior year and a decrease of $214.1 million in Retail Pharmacy segment gross profit. Gross margin was 23.7% for fiscal 2017 compared to 25.5% in fiscal 2016, due primarily to lower reimbursement rates in the Retail Pharmacy segment that were not offset by lower prescription drug costs and revenue growth in our Pharmacy Services segment, which carries a lower gross margin as a percentage of revenue. Please see the section entitled "Segment Analysis" for a more detailed description of gross profit and gross margin results by segment.
Gross profit increased by $249.5 million in fiscal 2016 compared to fiscal 2015. Gross profit for fiscal 2016 includes gross profit of $230.8 million relating to our Pharmacy Services segment and an increase of $18.7 million in Retail Pharmacy segment gross profit. Gross margin was 25.5% for fiscal 2016 compared to 28.6% in fiscal 2015, due to the inclusion of our Pharmacy Services segment in our fiscal 2016 results.
Selling, General and Administrative Expenses
SG&A increased by $229.0 million in fiscal 2017 compared to fiscal 2016. The increase in SG&A includes an incremental increase of $104.8 million relating to our Pharmacy Services segment due to a full year of Pharmacy Services segment operating results being included in the current year as compared to a partial year in the prior year and an increase of $124.2 million relating to our Retail Pharmacy segment. Please see the section entitled "Segment Analysis" below for additional details regarding SG&A.
SG&A increased by $317.7 million in fiscal 2016 compared to fiscal 2015. The increase in SG&A includes $188.6 million relating to our Pharmacy Services segment and an increase of $129.1 million relating to our Retail Pharmacy segment.
42
Lease Termination and Impairment Charges
Impairment Charges:
We evaluate long-lived assets for impairment whenever events or changes in circumstances indicate that an asset group has a carrying value that may not be recoverable. The individual operating store is the lowest level for which cash flows are identifiable. As such, we evaluate individual stores for recoverability of assets. To determine if a store needs to be tested for recoverability, we consider items such as decreases in market prices, changes in the manner in which the store is being used or physical condition, changes in legal factors or business climate, an accumulation of losses significantly in excess of budget, a current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection of continuing losses, or an expectation that the store will be closed or sold.
We monitor new and recently relocated stores against operational projections and other strategic factors such as regional economics, new competitive entries and other local market considerations to determine if an impairment evaluation is required. For other stores, we perform a recoverability analysis if they have experienced current-period and historical cash flow losses.
In performing the recoverability test, we compare the expected future cash flows of a store to the carrying amount of its assets. Significant judgment is used to estimate future cash flows. Major assumptions that contribute to our future cash flow projections include expected sales, gross profit, and distribution expenses; expected costs such as payroll, occupancy costs and advertising expenses; and estimates for other significant selling, and general and administrative expenses. Additionally, we take into consideration that certain operating stores are executing specific improvement plans which are monitored quarterly to recoup recent capital investments, such as an acquisition of an independent pharmacy, which we have made to respond to specific competitive or local market conditions, or have specific programs tailored towards a specific geography or market.
We recorded impairment charges of $32.1 million in fiscal 2017, $17.2 million in fiscal 2016 and $14.4 million in fiscal 2015. Our methodology for recording impairment charges has been consistently applied in the periods presented.
At March 4, 2017, approximately $2.0 billion of our long-lived assets, including intangible assets, were associated with 4,536 active operating stores.
If an operating store's estimated future undiscounted cash flows are not sufficient to cover its carrying value, its carrying value is reduced to fair value which is its estimated future discounted cash flows. The discount rate is commensurate with the risks associated with the recovery of a similar asset.
An impairment charge is recorded in the period that the store does not meet its original return on investment and/or has an operating loss for the last two years and its projected cash flows do not exceed its current asset carrying value. The amount of the impairment charge is the entire difference between the current carrying asset value and the estimated fair value of the assets using discounted future cash flows. Most stores are fully impaired in the period that the impairment charge is originally recorded.
We recorded impairment charges for active stores of $30.1 million in fiscal 2017, $16.1 million in fiscal 2016 and $12.1 million in fiscal 2015.
We review key performance results for active stores on a quarterly basis and approve certain stores for closure. Impairment for closed stores, if any (many stores are closed on lease expiration), are recorded in the quarter the closure decision is approved. Closure decisions are made on an individual store or regional basis considering all of the macro-economic, industry and other factors, in addition to, the operating store's individual operating results. We currently have no plans to close a significant number of active stores in future periods. We recorded impairment charges for closed facilities of $2.0 million in fiscal 2017, $1.1 million in fiscal 2016 and $2.3 million in fiscal 2015.
43
The following table summarizes the impairment charges and number of locations, segregated by closed facilities and active stores that have been recorded in fiscal 2017, 2016 and 2015:
|
Year Ended | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
March 4, 2017 | February 27, 2016 | February 28, 2015 | ||||||||||||||||
(in thousands, except number of stores) |
Number | Charge | Number | Charge | Number | Charge | |||||||||||||
Active stores: |
|||||||||||||||||||
Stores previously impaired(1) |
428 | $ | 9,426 | 357 | $ | 9,183 | 376 | $ | 6,949 | ||||||||||
New, relocated and remodeled stores(2) |
22 | 13,232 | 3 | 1,649 | 2 | 1,108 | |||||||||||||
Remaining stores not meeting the recoverability test(3) |
50 | 7,451 | 29 | 5,274 | 16 | 4,069 | |||||||||||||
| | | | | | | | | | | | | | | | | | | |
Total impairment charges-active stores |
500 | 30,109 | 389 | 16,106 | 394 | 12,126 | |||||||||||||
Total impairment charges-closed facilities |
53 | 2,038 | 27 | 1,113 | 35 | 2,312 | |||||||||||||
| | | | | | | | | | | | | | | | | | | |
Total impairment charges-all locations |
553 | $ | 32,147 | 416 | $ | 17,219 | 429 | $ | 14,438 | ||||||||||
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
The primary drivers of our impairment charges are each store's current and historical operating performance and the assumptions that we make about each store's operating performance in future periods. Projected cash flows are updated based on the next year's operating budget which includes the qualitative factors noted above. We are unable to predict with any degree of certainty which individual stores will fall short or exceed future operating plans. Accordingly, we are unable to describe future trends that would affect our impairment charges, including the likely stores and their related asset values that may fail their recoverability test in future periods.
To the extent that actual future cash flows may differ from our projections materially certain stores that are either not impaired or partially impaired in the current period may be further impaired in future periods. A 50 basis point decrease in our future sales assumptions as of March 4, 2017 would have resulted in an additional fiscal 2017 impairment charge of $2.7 million. A 50 basis point increase in our future sales assumptions as of March 4, 2017 would have reduced the fiscal 2017 impairment charge by $0.5 million. A 100 basis point decrease in our future sales assumptions as of March 4, 2017 would have resulted in an additional fiscal 2017 impairment charge of $3.3 million. A 100 basis point
44
increase in our future sales assumptions as of March 4, 2017 would have reduced the fiscal 2017 impairment charge by $0.9 million.
Lease Termination Charges: Charges to close a store, which principally consist of continuing lease obligations, are recorded at the time the store is closed and all inventory is liquidated, pursuant to the guidance set forth in ASC 420, "Exit or Disposal Cost Obligations." We calculate our liability for closed stores on a store-by-store basis. The calculation includes the discounted effect of 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. We evaluate these assumptions each quarter and adjust the liability accordingly. As part of our ongoing business activities, we assess stores and distribution centers for potential closure and relocation. Decisions to close or relocate stores or distribution centers in future periods would result in lease termination charges for lease exit costs and liquidation of inventory, as well as impairment of assets at these locations.
In fiscal 2017, 2016 and 2015, we recorded lease termination charges of $23.1 million, $31.2 million and $27.5 million, respectively. These charges related to changes in future assumptions, interest accretion and provisions for 17 stores in fiscal 2017, 23 stores in fiscal 2016 and 10 stores in fiscal 2015. We have no plans to close a significant number of stores in future periods.
Interest Expense
In fiscal 2017, 2016, and 2015, interest expense was $432.0 million, $449.6 million and $397.6 million, respectively. The decrease in interest expense in fiscal 2017 was the result of the cycling of the amortization of the bridge loan commitment fee from the EnvisionRx acquisition in the prior year. The increase in interest expense in fiscal 2016 was a result of the $1.8 billion aggregate principal amount borrowings from the issuance of our 6.125% Notes, which were used to finance the majority of the cash portion of our acquisition of EnvisionRx and the amortization of the bridge loan commitment fee from the EnvisionRx acquisition, partially offset by interest expense reductions from the August 2015 redemption of the outstanding $650.0 million aggregate principal amount of our 8.00% Notes, and the refinancing of our senior secured credit facility during the fourth quarter of fiscal 2015.
The annual weighted average interest rates on our indebtedness in fiscal 2017, 2016 and 2015 were 5.4%, 5.4% and 5.8%, respectively.
Income Taxes
Income tax expense of $44.4 million, income tax expense of $112.9 million and income tax benefit of $1,682.4 million, has been recorded for fiscal 2017, 2016 and 2015, respectively. Net income for fiscal 2017 included a provision for income tax based on an overall tax rate of 91.6%. The Company's effective tax rate is disproportionately high in fiscal 2017 from comparative periods due to low income before taxes relative to items that impact the effective tax rate. Net income for fiscal 2016 included a provision for income tax based on an overall tax rate of 40.6%.
ASC 740, "Income Taxes" requires a company to evaluate its deferred tax assets on a regular basis to determine if a valuation allowance against the net deferred tax assets is required. We take into account all available positive and negative evidence with regard to the recognition of a deferred tax asset including our past earnings history, expected future earnings, the character and jurisdiction of such earnings, unsettled circumstances that, if unfavorably resolved, would adversely affect recognition of a deferred tax asset, carryback and carryforward periods and tax planning strategies that could potentially enhance the likelihood of realization of a deferred tax asset. The ultimate realization of deferred tax assets is dependent upon the existence of sufficient taxable income generated in the carryforward periods. Accordingly, changes in the valuation allowance from period to period are included in the tax provision in the period of change.
45
Net income for fiscal 2015 included income tax benefit of $1,841.3 million attributable to the reduction of the deferred tax valuation allowance. The reduction of the valuation allowance is the result of an accumulation of objective and verifiable positive evidence out weighing the negative evidence. Through fiscal 2014, we had a cumulative loss over a three year window. Our positive evidence of sustained profitability includes the following: the achievement of cumulative profitability in fiscal 2015, reported earnings for ten consecutive quarters, established a pattern of utilization of federal and state net operating losses against taxable income over the last three years and demonstrated the Company's historical ability of predicting earnings such that management concluded that forecasts can be used to estimate the future utilization of our loss carryforwards. Based upon the Company's projections of future taxable income over the periods in which the deferred tax assets are recoverable, management believes that it is more likely than not that the Company will realize the benefits of substantially all the net deferred tax assets existing at February 28, 2015.
We maintained a valuation allowance of $226.7 million and $212.0 million against remaining net deferred tax assets at fiscal year-end 2017 and 2016, respectively.
Dilutive Equity Issuances
On March 4, 2017, 1,053.7 million shares of common stock, which includes unvested restricted shares, were outstanding and an additional 33.9 million shares of common stock were issuable related to outstanding stock options.
On March 4, 2017, our 33.9 million shares of potentially issuable common stock consisted of the following (shares in thousands):
Strike price
|
Outstanding Stock Options(a) |
|||
---|---|---|---|---|
$0.99 and under |
461 | |||
$1.00 to $1.99 |
22,670 | |||
$2.00 to $2.99 |
3,741 | |||
$3.00 to $3.99 |
| |||
$4.00 to $4.99 |
2 | |||
$5.00 to $5.99 |
1 | |||
$6.00 to $6.99 |
1,324 | |||
$7.00 to $7.99 |
2,490 | |||
$8.00 and over |
3,201 | |||
| | | | |
Total issuable shares |
33,890 | |||
| | | | |
| | | | |
| | | | |
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Segment Analysis
We evaluate the Retail Pharmacy and Pharmacy Services segments' performance based on revenue, gross profit, and Adjusted EBITDA. The following is a reconciliation of our segments to the consolidated financial statements:
|
Retail Pharmacy |
Pharmacy Services |
Intersegment Eliminations(1) |
Consolidated | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
(Dollars in thousands) |
||||||||||||
March 4, 2017: |
|||||||||||||
Revenues |
$ | 26,816,669 | $ | 6,393,884 | $ | (365,480 | ) | $ | 32,845,073 | ||||
Gross Profit |
7,381,333 | 392,732 | | 7,774,065 | |||||||||
Adjusted EBITDA(*) |
948,906 | 188,235 | | 1,137,141 | |||||||||
February 27, 2016: |
|||||||||||||
Revenues |
$ | 26,865,931 | $ | 4,103,513 | $ | (232,787 | ) | $ | 30,736,657 | ||||
Gross Profit |
7,595,429 | 230,826 | | 7,826,255 | |||||||||
Adjusted EBITDA(*) |
1,300,905 | 101,357 | | 1,402,262 | |||||||||
February 28, 2015: |
|||||||||||||
Revenues |
$ | 26,528,377 | $ | | $ | | $ | 26,528,377 | |||||
Gross Profit |
7,576,732 | | | 7,576,732 | |||||||||
Adjusted EBITDA(*) |
1,322,843 | | | 1,322,843 |
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Retail Pharmacy Segment Results of Operations
Revenues and Other Operating Data
|
Year Ended | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
March 4, 2017 (53 Weeks) |
February 27, 2016 (52 Weeks) |
February 28, 2015 (52 Weeks) |
|||||||
|
(Dollars in thousands) |
|||||||||
Revenues |
$ | 26,816,669 | $ | 26,865,931 | $ | 26,528,377 | ||||
Revenue (decline) growth |
(0.2 | )% | 1.3 | % | 3.9 | % | ||||
Same store sales (decline) growth |
(2.2 | )% | 1.3 | % | 4.3 | % | ||||
Pharmacy sales (decline) growth |
(3.3 | )% | 1.8 | % | 5.1 | % | ||||
Same store prescription count growth, adjusted to 30-day equivalents |
0.1 | % | 1.5 | % | 4.4 | % | ||||
Same store pharmacy sales (decline) growth |
(3.2 | )% | 1.8 | % | 5.8 | % | ||||
Pharmacy sales as a % of total retail sales |
68.3 | % | 69.1 | % | 68.8 | % | ||||
Third party sales as a % of total pharmacy sales |
98.2 | % | 97.8 | % | 97.5 | % | ||||
Front-end sales growth |
0.3 | % | 0.1 | % | 0.8 | % | ||||
Same store front-end sales growth |
0.2 | % | 0.2 | % | 1.2 | % | ||||
Front-end sales as a % of total retail sales |
31.7 | % | 30.9 | % | 31.2 | % | ||||
Adjusted EBITDA(*) |
$ | 948,906 | $ | 1,300,905 | $ | 1,322,843 | ||||
Store data: |
||||||||||
Total stores (beginning of period) |
4,561 | 4,570 | 4,587 | |||||||
New stores |
12 | 5 | 2 | |||||||
Store acquisitions |
3 | 6 | 9 | |||||||
Closed stores |
(40 | ) | (20 | ) | (28 | ) | ||||
Total stores (end of period) |
4,536 | 4,561 | 4,570 | |||||||
Relocated stores |
24 | 20 | 14 | |||||||
Remodeled and expanded stores |
350 | 414 | 445 |
Revenues
Fiscal 2017 compared to Fiscal 2016: The 0.2% decrease in revenue was due primarily to a decrease in pharmacy same store sales, partially offset by the extra week in fiscal 2017. Same store sales trends for fiscal 2017 and fiscal 2016 are described in the following paragraphs. We include in same store sales all stores that have been open at least one year. Stores in liquidation are considered closed. Relocation stores are not included in same store sales until one year has lapsed.
Pharmacy same store sales decreased 3.2%. Pharmacy same store sales were negatively impacted by continued reimbursement rate pressures and the continued impact of increases in generic drugs, which have a substantially lower selling price than their brand counterparts but higher gross profit. We expect lower reimbursement rates to continue to have a negative impact on our revenues.
Front end same store sales increased 0.2%. The increase in same store front end sales was impacted by incremental sales from our 2,418 Wellness format stores, and other management initiatives to increase front end sales.
Fiscal 2016 compared to Fiscal 2015: The 1.3% increase in revenue was due primarily to an increase in pharmacy and front end same store sales.
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Pharmacy same store sales increased 1.8%. Pharmacy same store sales were positively impacted by an increase of 1.49% in same store prescription count, which reflects higher utilization in Medicaid expansion states and an increase in immunizations, and brand drug inflation. The increases were partially offset by the continued impact of increases in generic drugs, which have a substantially lower selling price than their brand counterparts but higher gross profit. Pharmacy same store sales were also negatively impacted by continued reimbursement rate pressures.
Front end same store sales increased 0.2%. The increase in same store front end sales was impacted by incremental sales from our 2,042 Wellness format stores, and other management initiatives to increase front end sales.
Costs and Expenses
|
Year Ended | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
March 4, 2017 (53 Weeks) |
February 27, 2016 (52 Weeks) |
February 28, 2015 (52 Weeks) |
|||||||
|
(Dollars in thousands) |
|||||||||
Costs of revenues |
$ | 19,435,336 | $ | 19,270,502 | $ | 18,951,645 | ||||
Gross profit |
7,381,333 | 7,595,429 | 7,576,732 | |||||||
Gross margin |
27.5 | % | 28.3 | % | 28.6 | % | ||||
FIFO gross profit(*) |
7,374,713 | 7,606,592 | 7,557,875 | |||||||
FIFO gross margin(*) |
27.5 | % | 28.3 | % | 28.5 | % | ||||
Selling, general and administrative expenses |
$ | 6,948,860 | $ | 6,824,698 | $ | 6,695,642 | ||||
Selling, general and administrative expenses as a percentage of revenues |
25.9 | % | 25.4 | % | 25.2 | % |
Gross Profit and Cost of Revenues
Gross profit decreased by $214.1 million in fiscal 2017 compared to fiscal 2016. The decrease in gross profit is due to lower pharmacy gross profit driven by reductions in reimbursement rates that we could not offset through generic purchasing efficiencies, partially offset by the extra week in fiscal 2017.
Overall gross margin was 27.5% for fiscal 2017 compared to 28.3% in fiscal 2016. Gross margin was lower due primarily to continued pharmacy reimbursement rate pressures that we could not offset through generic purchasing efficiencies, partially offset by a LIFO credit as compared to a LIFO charge in the prior year. We expect lower reimbursement rates to continue to have a negative impact on our gross margin.
Gross profit increased by $18.7 million in fiscal 2016 compared to fiscal 2015. The increase in gross profit was due to an increase in front end gross profit, partially offset by lower pharmacy gross profit and a LIFO charge of $11.2 million in fiscal 2016 versus a LIFO credit of $18.9 million in fiscal 2015. The fiscal 2016 LIFO charge was primarily due to lower deflation on pharmacy generics, than in fiscal 2015. Overall gross margin was 28.3% for fiscal 2016 compared to 28.6% in fiscal 2015.
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. The LIFO credit for fiscal 2017 was $6.6 million compared to a LIFO charge of $11.2 million in fiscal 2016 and a LIFO credit of $18.9 million in fiscal 2015. The LIFO credit for fiscal 2017 as compared to the prior year LIFO charge is due primarily to lower brand drug inflation and deflation in generic prescription drug costs.
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During fiscal 2015, we experienced higher generic deflation and lower pharmacy inventory in our distribution centers resulting from our Purchasing and Delivery Arrangement, which contributed to a LIFO credit of $18.9 million.
Selling, General and Administrative Expenses
SG&A as a percentage of revenue was 25.9% in fiscal 2017 compared to 25.4% in fiscal 2016, an increase of $124.2 million. The increase in SG&A for fiscal 2017 was a result of the extra week in fiscal 2017 and declining Retail Pharmacy segment sales leverage.
SG&A as a percentage of revenue was 25.4% in fiscal 2016 compared to 25.2% in fiscal 2015, an increase of $129.1 million. The increase in SG&A for fiscal 2016 was a result of increased payroll and benefit costs, higher depreciation and amortization related to our increased capital spending, and expenses relating to our acquisition of EnvisionRx and our pending Merger with WBA.
Pharmacy Services Segment Results of Operations
Acquisition of EnvisionRx
On June 24, 2015, we completed our acquisition of EnvisionRx, pursuant to the terms of the agreement ("Agreement") dated February 10, 2015. EnvisionRx, our Pharmacy Services segment, is a full-service pharmacy benefit provider. EnvisionRx provides both transparent and traditional PBM options through its EnvisionRx and MedTrak PBMs. EnvisionRx also offers fully integrated mail-order and specialty pharmacy services through EnvisionPharmacies; access to the nation's largest cash pay infertility discount drug program via Design Rx; an innovative claims adjudication software platform in Laker Software; and a national Medicare Part D prescription drug plan through EIC's EnvisionRx Plus Silver product for the low income auto-assign market and its Clear Choice product for the chooser market. EnvisionRx operates as our 100 percent owned subsidiary. We believe that the acquisition of EnvisionRx will enable us to expand our retail healthcare platform and enhance our health and wellness offerings by combining EnvisionRx's broad suite of PBM and pharmacy-related businesses with our established retail platform to provide our customers and patients with an integrated offering across retail, specialty and mail-order channels.
Pharmacy Services Segment Results of Operations
Pharmacy Services segment revenue for fiscal 2017 was $6,393.9 million as compared to fiscal 2016 revenue of $4,103.5 million. The increase in the fiscal 2017 revenue for the segment is primarily due to a full year of Pharmacy Services segment operations being included in the current year as compared to a partial year in the prior year. In addition, revenues for fiscal 2017 were positively impacted by revenue growth at EnvisionPharmacies and DesignRx.
Gross profit for fiscal 2017 was $392.7 million as compared to gross profit of $230.8 million for fiscal 2016. The increase in the fiscal 2017 gross profit for the segment is primarily due to a full year of Pharmacy Services segment operating results being included in the current year as compared to a partial year in the prior year. In addition, gross profit for fiscal 2017 was positively impacted by customer additions and growth at EnvisionPharmacies and DesignRx.
Pharmacy Services segment selling, general and administrative expenses for fiscal 2017 was $293.5 million as compared to $188.6 million of selling, general and administrative expenses for fiscal 2016. The increase in the selling, general and administrative expenses for fiscal 2017 is primarily the result of a full period of operating results in the current year as compared to a partial period of operating results in the prior year, as well as from additional costs to service new Pharmacy Services customers. Selling, general and administrative expenses as a percentage of Pharmacy Services segment revenue was 4.6% in fiscal 2017 and fiscal 2016.
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Pharmacy Services Adjusted EBITDA for fiscal 2017 was $188.2 million or 2.9 percent of Pharmacy Services revenue as compared to $101.4 million or 2.5 percent of Pharmacy Services revenue for fiscal 2016. The increase in fiscal 2017 Adjusted EBITDA for the segment is primarily due to an increase in revenues and the fact that prior year's Pharmacy Services segment results do not reflect a full year's ownership of EnvisionRx.
Liquidity and Capital Resources
General
We have two primary sources of liquidity: (i) cash provided by operating activities and (ii) borrowings under our Amended and Restated Senior Secured Credit Facility. Our principal uses of cash are to provide working capital for operations, to service our obligations to pay interest and principal on debt and to fund capital expenditures. Total liquidity as of March 4, 2017 was $1,288.0 million, which consisted of revolver borrowing capacity of $1,207.7 million and invested cash of $80.3 million.
Credit Facilities
Our Amended and Restated Senior Secured Credit Facility has a borrowing capacity of $3.7 billion and matures in January 2020. Borrowings under the revolver bear interest at a rate per annum between (i) LIBOR plus 1.50% and LIBOR plus 2.00% with respect to Eurodollar borrowings and (ii) the alternate base rate plus 0.50% and the alternate base rate plus 1.00% with respect to ABR borrowings, in each case, based upon the average revolver availability (as defined in the Amended and Restated Senior Secured Credit Facility). We are required to pay fees between 0.250% and 0.375% per annum on the daily unused amount of the revolver, depending on the Average Revolver Availability (as defined in the Amended and Restated Senior Secured Credit Facility). Amounts drawn under the revolver become due and payable on January 13, 2020.
Our ability to borrow under the revolver is based upon a specified borrowing base consisting of accounts receivable, inventory and prescription files. At March 4, 2017, we had $2,430.0 million of borrowings outstanding under the revolver and had letters of credit outstanding against the revolver of $62.3 million, which resulted in additional borrowing capacity of $1,207.7 million. If at any time the total credit exposure outstanding under our Amended and Restated Senior Secured Credit Facility and the principal amount of our other senior obligations exceeds the borrowing base, we will be required to make certain other mandatory prepayments to eliminate such shortfall. Additionally, the Merger Agreement limits our ability to incur additional indebtedness for borrowed money, including a requirement that borrowings under the revolver not exceed $3.0 billion in the aggregate immediately prior to the closing of the Merger.
The Amended and Restated Senior Secured Credit Facility restricts us and all of our subsidiaries that guarantee our obligations under the Amended and Restated Senior Secured Credit Facility, second priority secured term loan facilities, secured guaranteed notes and unsecured guaranteed notes (the "Subsidiary Guarantors") from accumulating cash on hand in excess of $200.0 million at any time when revolving loans are outstanding (not including cash located in our store and lockbox deposit accounts and cash necessary to cover our current liabilities) and from accumulating cash on hand with revolver borrowings in excess of $100.0 million over three consecutive business days. The Amended and Restated Senior Secured Credit Facility also states that if at any time (other than following the exercise of remedies or acceleration of any senior obligations or second priority debt and receipt of a triggering notice by the senior collateral agent from a representative of the senior obligations or the second priority debt) either (a) an event of default exists under our Amended and Restated Senior Secured Credit Facility or (b) the sum of revolver availability under our Amended and Restated Senior Secured Credit Facility and certain amounts held on deposit with the senior collateral agent in a concentration
51
account is less than $275.0 million for three consecutive business days or less than or equal to $200.0 million on any day (a "cash sweep period"), the funds in our deposit accounts will be swept to a concentration account with the senior collateral agent and will be applied first to repay outstanding revolving loans under the Amended and Restated Senior Secured Credit Facility, and then held as collateral for the senior obligations until such cash sweep period is rescinded pursuant to the terms of our Amended and Restated Senior Secured Credit Facility.
The Amended and Restated Senior Secured Credit Facility allows us to have outstanding, at any time, up to $1.5 billion in secured second priority debt, split-priority term loan debt, unsecured debt and disqualified preferred stock in addition to borrowings under the Amended and Restated Senior Secured Credit Facility and existing indebtedness, provided that not in excess of $750.0 million of such secured second priority debt, split-priority term loan debt, unsecured debt and disqualified preferred stock shall mature or require scheduled payments of principal prior to 90 days after the latest of (a) the fifth anniversary of the effectiveness of the Amended and Restated Senior Secured Credit Facility and (b) the latest maturity date of any Term Loan or Other Revolving Loan (each as defined in the Amended and Restated Senior Secured Credit Facility) (excluding bridge facilities allowing extensions on customary terms to at least the date that is 90 days after such date and, with respect to any escrow notes issued by Rite Aid, excluding any special mandatory redemption of the type described in clause (iii) of the definition of "Escrow Notes" in the Amended and Restated Senior Secured Credit Facility). Subject to the limitations described in clauses (a) and (b) of the immediately preceding sentence, the Amended and Restated Senior Secured Credit Facility additionally allows us to issue or incur an unlimited amount of unsecured debt and disqualified preferred stock so long as a Financial Covenant Effectiveness Period (as defined in the Amended and Restated Senior Secured Credit Facility) is not in effect; provided, however, that certain of our other outstanding indebtedness limits the amount of unsecured debt that can be incurred if certain interest coverage levels are not met at the time of incurrence or other exemptions are not available. The Amended and Restated Senior Secured Credit Facility also contains certain restrictions on the amount of secured first priority debt we are able to incur. The Amended and Restated Senior Secured Credit Facility also allows for the voluntary repurchase of any debt or other convertible debt, so long as the Amended and Restated Senior Secured Credit Facility is not in default and we maintain availability under our revolver of more than $365.0 million.
The Amended and Restated Senior Secured Credit Facility has a financial covenant that requires us to maintain a minimum fixed charge coverage ratio of 1.00 to 1.00 (a) on any date on which availability under the revolver is less than $200.0 million or (b) on the third consecutive business day on which availability under the revolver is less than $250.0 million and, in each case, ending on and excluding the first day thereafter, if any, which is the 30th consecutive calendar day on which availability under the revolver is equal to or greater than $250.0 million. As of March 4, 2017, we had availability under our revolver of $1,207.7 million, our fixed charge coverage ratio was greater than 1.00 to 1.00, and we were in compliance with the senior secured credit facility's financial covenant. The Amended and Restated Senior Secured Credit Facility also contains covenants which place restrictions on the incurrence of debt, the payments of dividends, sale of assets, mergers and acquisitions and the granting of liens.
The Amended and Restated 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 we fail to make any required payment on debt having a principal amount in excess of $50.0 million or any event occurs that enables, or which with the giving of notice or the lapse of time would enable, the holder of such debt to accelerate the maturity or require the repayment repurchase, redemption or defeasance of such debt.
We also have two second priority secured term loan facilities, the Tranche 1 Term Loan and the Tranche 2 Term Loan. The Tranche 1 Term Loan matures on August 21, 2020 and currently bears
52
interest at a rate per annum equal to LIBOR plus 4.75% with a LIBOR floor of 1.00%, if we choose to make LIBOR borrowings, or at Citibank's base rate plus 3.75%. The Tranche 2 Term Loan matures on June 21, 2021 and currently bears interest at a rate per annum equal to LIBOR plus 3.875% with a LIBOR floor of 1.00%, if we choose to make LIBOR borrowings, or at Citibank's base rate plus 2.875%.
The second priority secured term loan facilities and the indentures that govern our secured and guaranteed unsecured notes contain restrictions on the amount of additional secured and unsecured debt that can be incurred by us. As of March 4, 2017, the amount of additional secured debt that could be incurred under the most restrictive covenant of the second priority secured term loan facilities and these indentures was approximately $1.6 billion (which amount does not include the ability to enter into certain sale and leaseback transactions). Assuming a fully drawn revolver and the outstanding letters of credit, we could incur an additional $350.0 million in secured debt. The ability to issue additional unsecured debt under these indentures is generally governed by an interest coverage ratio test. As of March 4, 2017, we had the ability to issue additional unsecured debt under the second lien credit facilities and other indentures.
2016 Transactions
On April 2, 2015, we issued $1.8 billion aggregate principal amount of our 6.125% Notes to finance the majority of the cash portion of our acquisition of EnvisionRx, which closed on June 24, 2015. Our obligations under the notes are fully and unconditionally guaranteed, jointly and severally, on an unsubordinated basis, by all of our subsidiaries that guarantee our obligations under the Amended and Restated Senior Secured Credit Facility, the Tranche 1 Term Loan, the Tranche 2 Term Loan, the 9.25% senior notes due 2020 (the "9.25% Notes") and the 6.75% senior notes due 2021 (the "6.75% Notes") (the "Rite Aid Subsidiary Guarantors"), including EnvisionRx and certain of its domestic subsidiaries other than EIC (the "EnvisionRx Subsidiary Guarantors" and, together with the Rite Aid Subsidiary Guarantors, the "Subsidiary Guarantors"). The guarantees are unsecured. The 6.125% Notes are unsecured, unsubordinated obligations of Rite Aid Corporation and rank equally in right of payment with all of our other unsecured, unsubordinated indebtedness.
During May 2015, $64.1 million of our 8.5% convertible notes due 2015 were converted into 24.8 million shares of common stock, pursuant to their terms. The remaining $0.1 million of our 8.5% convertible notes due 2015 were repaid by us upon maturity.
On August 15, 2015, we completed the redemption of all of our outstanding $650.0 million aggregate principal amount of our 8.00% Notes. In connection with the redemption, we recorded a loss on debt retirement, including call premium and unamortized debt issue costs of $33.2 million during the second quarter of fiscal 2016.
2015 Transactions
On October 15, 2014, we completed the redemption of all of the outstanding $270.0 million aggregate principal amount of 10.25% senior notes due October 2019 at their contractually determined early redemption price of 105.125% of the principal amount, plus accrued interest. We funded this redemption with borrowings under our revolver. We recorded a loss on debt retirement of $18.5 million related to this transaction.
Off-Balance Sheet Arrangements
As of March 4, 2017, we had no material off balance sheet arrangements, other than operating leases as included in the table below.
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Contractual Obligations and Commitments
The following table details the maturities of our indebtedness and lease financing obligations as of March 4, 2017, as well as other contractual cash obligations and commitments.
|
Payment due by period | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Less Than 1 Year |
1 to 3 Years | 3 to 5 Years | After 5 Years | Total | |||||||||||
|
(Dollars in thousands) |
|||||||||||||||
Contractual Cash Obligations |
||||||||||||||||
Long term debt(1) |
$ | 390,681 | $ | 3,203,220 | $ | 3,136,487 | $ | 2,526,800 | $ | 9,257,188 | ||||||
Capital lease obligations(2) |
26,184 | 26,116 | 11,837 | 25,743 | 89,880 | |||||||||||
Operating leases(3) |
1,050,834 | 1,857,661 | 1,383,671 | 3,054,697 | 7,346,863 | |||||||||||
Open purchase orders |
201,685 | | | | 201,685 | |||||||||||
Other, primarily self insurance and retirement plan obligations(4) |
98,669 | 86,271 | 25,113 | 69,632 | 279,685 | |||||||||||
Minimum purchase commitments(5) |
168,723 | 341,643 | 26,191 | | 536,557 | |||||||||||
| | | | | | | | | | | | | | | | |
Total contractual cash obligations |
$ | 1,936,776 | $ | 5,514,911 | $ | 4,583,299 | $ | 5,676,872 | $ | 17,711,858 | ||||||
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Commitments |
||||||||||||||||
Lease guarantees(6) |
$ | 16,624 | $ | 22,604 | $ | 4,823 | $ | 1,371 | $ | 45,422 | ||||||
Outstanding letters of credit |
56,678 | 5,594 | | | 62,272 | |||||||||||
| | | | | | | | | | | | | | | | |
Total commitments |
$ | 2,010,078 | $ | 5,543,109 | $ | 4,588,122 | $ | 5,678,243 | $ | 17,819,552 | ||||||
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Obligations for income tax uncertainties pursuant to ASC 740, "Income Taxes" of approximately $0.9 million are not included in the table above as we are uncertain as to if or when such amounts may be settled.
Net Cash Provided By (Used In) Operating, Investing and Financing Activities
Cash flow provided by operating activities was $225.9 million in fiscal 2017. Cash flow was negatively impacted by cash used by other assets and liabilities, which relates primarily to increased prepaid rent and decreases in various accrued liabilities, cash used by accounts receivable, which relates primarily to our Pharmacy Services segment accounts receivable growth, and cash used by inventory, which relates primarily to increasing store pharmacy inventory following a period of inventory reductions.
54
Cash flow provided by operating activities was $997.4 million in fiscal 2016. Cash flow was positively impacted by net income and a decrease in inventory. The cash provided by accounts receivable and used by other assets and liabilities, relate primarily to the receipt of amounts due from CMS and the corresponding payment of amounts due under certain reinsurance contracts, as well as residual amounts due to TPG under the Acquisition agreement, which relate to the December 31, 2014 CMS plan year.
Cash flow provided by operating activities was $649.0 million in fiscal 2015. Cash flow was positively impacted by net income and a decrease in inventory. These cash inflows were partially offset by a reduction of accounts payable resulting from the inventory reduction and the timing of payments, cash used in other assets and liabilities, net, due primarily to lower closed store reserves and self-insurance liability and higher accounts receivable due primarily to increased pharmacy sales and the timing of payments.
Cash used in investing activities was $464.3 million in fiscal 2017. Cash used in investing activities decreased as compared to the prior year due to expenditures of $1,778.4 million, net of cash acquired, related to the acquisition of EnvisionRx in the prior year. Cash used for the purchase of property, plant, and equipment was also lower than in the prior year due to fewer Wellness store remodels in the current year.
Cash used in investing activities was $2,401.9 million in fiscal 2016. Cash used in investing activities increased due to expenditures of $1,778.4 million, net of cash acquired, related to the acquisition of EnvisionRx compared to the fiscal 2015 expenditures of $69.8 million, net of cash acquired, related to the acquisitions of Health Dialog and RediClinic in April 2014. Cash used for the purchase of property, plant, and equipment was higher than in fiscal 2015 due to a higher investment in Wellness store remodels.
Cash used in investing activities was $593.7 million in fiscal 2015. Cash used for the purchase of property, plant, and equipment and prescription files was higher than in fiscal 2014 due to a higher investment in Wellness store remodels and prescription file buys. Proceeds from the sale of assets were lower as compared to fiscal 2014. Also reflected in investing activities are expenditures of $69.8 million, net of cash acquired, related to the acquisitions of Health Dialog and RediClinic.
Cash provided by financing activities was $359.3 million in fiscal 2017, which reflects net proceeds from the revolver of $330.0 million. We also made scheduled payments of $21.2 million on our capital lease obligations. Cash provided by financing activities also reflects an increase in our zero balance bank accounts and proceeds from the issuance of common stock.
Cash provided by financing activities was $1,413.0 million in fiscal 2016, which reflects $1.8 billion in proceeds from our 6.125% Notes, which was used to finance the majority of the cash portion of our acquisition of EnvisionRx, which is included in investing activities, as well as net proceeds from the revolver of $375.0 million. We also redeemed $650.0 million of our 8.0% senior secured notes and made scheduled payments of $22.7 million on our capital lease obligations. Additionally, we paid an early redemption premium of $26.0 million in connection with the redemption of our 8.0% senior secured notes and deferred financing costs paid in connection with the January 2015 senior secured credit facility refinancing and 6.125% Notes proceeds. Cash provided by financing activities also reflects proceeds from the issuance of common stock and excess tax benefit on stock options, partially offset by a reduction in our zero balance bank accounts.
Cash used in financing activities was $85.8 million in fiscal 2015, which reflects proceeds from the issuance of our $1,152.3 million Tranche 7 Term Loan due 2020 ("Tranche 7 Term Loan"), net proceeds from our revolver of $1,325.0 million (which includes borrowings for the repayment and retirement of our $1,143.7 million Tranche 7 Term Loan), the repayment of our $1,152.3 million Tranche 6 Term Loan due 2020 and the redemption of $270.0 million of our 10.25% Senior Secured Notes due 2019.
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We also made scheduled payments of $21.1 million on our capital lease obligations and $8.6 million on our Tranche 7 Term Loan. Additionally, we paid an early redemption premium of $13.8 million in connection with the redemption of our 10.25% Senior Secured Notes due 2019 and deferred financing costs of $1.5 million and $18.8 million in connection with our Tranche 7 Term Loan due 2020 and January 2015 Senior Secured Credit Facility refinancing, respectively. Cash provided by financing activities also reflects proceeds from the issuance of common stock and excess tax benefit on stock options and an increase in our zero balance bank accounts.
Capital Expenditures
During the fiscal years ended March 4, 2017, February 27, 2016 and February 28, 2015 capital expenditures were as follows:
|
Year Ended | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
March 4, 2017 (53 weeks) |
February 27, 2016 (52 weeks) |
February 28, 2015 (52 weeks) |
|||||||
|
(Dollars in thousands) |
|||||||||
New store construction, store relocation and store remodel projects |
$ | 248,624 | $ | 311,820 | $ | 280,679 | ||||
Technology enhancements, improvements to distribution centers and other corporate requirements |
175,665 | 229,527 | 146,149 | |||||||
Purchase of prescription files from other retail pharmacies |
56,822 | 128,648 | 112,558 | |||||||
| | | | | | | | | | |
Total capital expenditures |
$ | 481,111 | $ | 669,995 | $ | 539,386 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
Future Liquidity
We are highly leveraged. Our high level of indebtedness could: (i) limit our ability to obtain additional financing; (ii) limit our flexibility in planning for, or reacting to, changes in our business and the industry; (iii) place us at a competitive disadvantage relative to our competitors with less debt; (iv) render us more vulnerable to general adverse economic and industry conditions; and (v) require us to dedicate a substantial portion of our cash flow to service our debt. Based upon our current levels of operations and after giving effect to limitations in the Merger Agreement, we believe that cash flow from operations together with available borrowings under the revolver and other sources of liquidity will be adequate to meet our requirements for working capital, debt service and capital expenditures at least for the next twelve months. Based on our liquidity position, which we expect to remain strong throughout the year, we do not expect to be subject to the fixed charge covenant in our senior secured credit facility in the next twelve months. We will continue to assess our liquidity position and potential sources of supplemental liquidity in light of our operating performance, and other relevant circumstances. Subject to the limitations set forth in the Merger Agreement, including the requirement that we obtain WBA's consent prior to engaging in certain transactions, from time to time, we may seek deleveraging transactions, including entering into transactions to exchange debt for shares of common stock, issuance of equity (including preferred stock and convertible securities), repurchase or redemption of outstanding indebtedness, or seek to refinance our outstanding debt (including our revolver) or may otherwise seek transactions to reduce interest expense and extend debt maturities. Additionally, the Merger Agreement contains a requirement that borrowings under the revolver not exceed $3.0 billion in the aggregate immediately prior to the closing of the Merger. Any of these transactions could impact our financial results. Upon closing of the Merger, we expect that all amounts due under the Amended and Restated Senior Secured Credit Facility, Tranche 1 Term Loan and Tranche 2 Term Loan will be paid in accordance with the terms of the Merger Agreement.
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Additionally, upon closing of the Merger, the indentures governing the 9.25% Notes, the 6.75% Notes and the 6.125% Notes require the Company or WBA to make a change of control offer to repurchase such notes from the noteholders at 101% plus accrued and unpaid interest, to the extent such notes remain outstanding at the closing.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to inventory shrink, goodwill impairment, impairment of long-lived assets, revenue recognition, vendor discounts and purchase discounts, self insurance liabilities, lease exit liabilities, income taxes and litigation. Additionally, we have critical accounting policies regarding revenue recognition and vendor allowances and purchase discounts for our Pharmacy Services segment. We base our estimates on historical experience, current and anticipated business conditions, the condition of the financial markets and various other assumptions that are believed to be reasonable under existing conditions. Variability reflected in the sensitivity analyses presented below is based on our recent historical experience. Actual results may differ materially from these estimates and sensitivity analyses.
The following critical accounting policies require the use of significant judgments and estimates by management:
Inventory shrink: The carrying value of our inventory is reduced by a reserve for estimated shrink losses that occur between physical inventory dates. When estimating these losses, we consider historical loss results at specific locations, as well as overall loss trends as determined during physical inventory procedures. The estimated shrink rate is calculated by dividing historical shrink results for stores inventoried in the most recent six months by the sales for the same period. Shrink expense is recognized by applying the estimated shrink rate to sales since the last physical inventory. There have been no significant changes in the assumptions used to calculate our shrink rate over the last three years. Although possible, we do not expect a significant change to our shrink rate in future periods. A 10 basis point difference in our estimated shrink rate for the year ended March 4, 2017, would have affected pre-tax income by approximately $9.8 million.
Goodwill Impairment: Our policy is to perform an impairment test of goodwill at least annually, and more frequently if events or circumstances occurred that would indicate a reduced fair value in our reporting units could exist. Typically, we perform a qualitative assessment in the fourth quarter of the fiscal year to determine if it is more likely than not that the carrying value of the goodwill exceeds the fair value of the goodwill. However, as part of this qualitative assessment, we do perform a quantitative assessment at least once every three years to re-establish a baseline fair value that can be used in our current and future qualitative assessments. During our qualitative assessment we make significant estimates, assumptions, and judgments, including, but not limited to, the overall economy, industry and market conditions, financial performance of the Company, changes in our share price, and forecasts of revenue, profit, working capital requirements, and cash flows. We consider each reporting unit's historical results and operating trends when determining these assumptions; however, our estimates and projections can be affected by a number of factors and it is possible that actual results could differ from the assumptions used in our impairment assessment. If we determine that it is more likely than not that the carrying value of the goodwill exceeds the fair value of the goodwill, we perform the first step of the impairment process, which compares the fair value of the reporting unit to its carrying amount, including the goodwill. Fair value estimates used in the quantitative impairment test are calculated using an average of an income and market approaches. The income approach is based on
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the present value of future cash flows of each reporting unit, while the market approach is based on certain multiples of selected guideline public companies or selected guideline transactions. The approaches incorporate a number of assumptions including future growth rates, discount rates, income tax rates and market activity in assessing fair value and are reporting unit specific. If the carrying value of the reporting unit exceeds the fair value, the second step of the impairment process is performed and the implied fair value of the reporting unit is compared to the carrying amount of the goodwill. The implied fair value of the goodwill is determined the same way as the goodwill recognized in a business combination. We assign the fair value of a reporting unit to all of the assets and liabilities of that unit (including unrecognized intangible assets) and any excess goes to the goodwill (its implied fair value). Any excess carrying amount of the goodwill over the implied fair value of the goodwill, is the amount of the impairment loss recognized.
Impairment of long-lived assets: We evaluate long-lived assets for impairment whenever events or changes in circumstances indicate that an asset group has a carrying value that may not be recoverable. The individual operating store is the lowest level for which cash flows are identifiable. As such, we evaluate individual stores for recoverability. To determine if a store needs to be tested for recoverability, we consider items such as decreases in market prices, changes in the manner in which the store is being used or physical condition, changes in legal factors or business climate, an accumulation of losses significantly in excess of budget, a current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection of continuing losses, or an expectation that the store will be closed or sold.
We monitor new and recently relocated stores against operational projections and other strategic factors such as regional economics, new competitive entries and other local market considerations to determine if an impairment evaluation is required. For other stores, we perform a recoverability analysis if they have experienced current-period and historical cash flow losses.
In performing the recoverability test, we compare the expected future cash flows of a store to the carrying amount of its assets. Significant judgment is used to estimate future cash flows. Major assumptions that contribute to our future cash flow projections include: expected sales and gross profit, pharmacy reimbursement rates, expected costs such as payroll, and estimates for other significant selling, general and administrative expenses.
If an operating store's estimated future undiscounted cash flows are not sufficient to cover its carrying value, its carrying value is reduced to fair value which is its estimated future discounted cash flows. The discount rate is commensurate with the risks associated with the recovery of a similar asset.
We regularly approve certain stores for closure. Impairment charges for closed stores, if any, are evaluated and recorded in the quarter the closure decision is approved.
We also evaluate assets to be disposed of on a quarterly basis to determine if an additional impairment charge is required. Fair value estimates are provided by independent brokers who operate in the local markets where the assets are located.
If our actual future cash flows differ from our projections materially, certain stores that are either not impaired or partially impaired in the current period may be further impaired in future periods. A 50 basis point decrease in our future sales assumptions as of March 4, 2017 would have resulted in an additional fiscal 2017 impairment charge of $2.7 million. A 50 basis point increase in our future sales assumptions as of March 4, 2017 would have reduced the fiscal 2017 impairment charge by $0.5 million. A 100 basis point decrease in our future sales assumptions as of March 4, 2017 would have resulted in an additional fiscal 2017 impairment charge of $3.3 million. A 100 basis point increase in our future sales assumptions as of March 4, 2017 would have reduced the fiscal 2017 impairment charge by $0.9 million.
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Revenue recognition for our loyalty program: We offer a chain wide customer loyalty program, "wellness+". Members participating in our wellness+ loyalty card program earn points on a calendar year basis for eligible front end merchandise purchases and qualifying prescriptions. One point is awarded for each dollar spent towards front end merchandise and 25 points are awarded for each qualifying prescription.
Members reach specific wellness+ tiers based on the points accumulated during the calendar year, which entitle them to certain future discounts and other benefits upon reaching that tier. For example, any customer that reaches 1,000 points in a calendar year achieves the "Gold" tier, enabling the customer to receive a 20% discount on qualifying purchases of front end merchandise for the remaining portion of the calendar year and the next calendar year. There is also a similar "Silver" level with a lower threshold and benefit level.
As wellness+ customers accumulate points, we defer the value of the points earned as deferred revenue based on the expected usage. The amount deferred is based on historic and projected customer activity (e.g., tier level, spending level). As customers receive discounted front end merchandise, we recognize an allocable portion of the deferred revenue. If the achieved combined Gold and Silver levels differ from the assumptions by 5.0% it would have affected pretax income by $1.3 million. If the assumed spending levels, which are the drivers of future discounts, differ by 5.0% it would have affected pretax income by $1.3 million.
Rite Aid has partnered with American Express Travel Related Services Company, Inc. to be part of a coalition loyalty program titled Plenti. This awards program allows a customer to earn points based on qualifying purchases at participating retailers. Each Plenti point is worth the equivalent of $0.01. The customer has the opportunity to redeem their accumulated points on a future purchase at any of the participating retailers. All points are redeemed using a FIFO methodology (e.g., first points earned are the first to be redeemed). Points expire on December 31st of each year for any point that has aged a minimum of two years that has not been redeemed by the customer.
For a majority of the Plenti point issuances, funding is provided by our vendors through contractual arrangements. This funding is treated as deferred revenue and remains in deferred revenue until a customer redeems their points. Upon redemption, the deferred revenue account is decremented with an offsetting credit to sales. For Plenti point redemptions that are not vendor funded, deferred revenue is recorded and not recognized until the points are redeemed.
Self-insurance liabilities: We expense claims for self-insured workers' compensation and general liability insurance coverage as incurred including an estimate for claims incurred but not paid. The expense for self-insured workers' compensation and general liability claims incurred but not paid is determined using several factors, including historical claims experience and development, severity of claims, medical costs and the time needed to settle claims. We discount the estimated expense for workers' compensation to present value as the time period from incurrence of the claim to final settlement can be several years. We base our estimates for such timing on previous settlement activity. The discount rate is based on the current market rates for Treasury bills that approximate the average time to settle the workers' compensation claims. These assumptions are updated on an annual basis. A 30 basis point difference in the discount rate for the year ended March 4, 2017, would have affected pretax income by approximately $2.6 million.
Lease termination charges: We record reserves for closed stores based on future lease commitments, anticipated ancillary occupancy costs and anticipated future subleases of properties. The reserves are calculated at the individual location level and the assumptions are assessed at that level. The reserve for lease exit liabilities is discounted using a credit adjusted risk free interest rate. Reserve estimates and related assumptions are updated on a quarterly basis.
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Changes in the real estate leasing markets can have an impact on the closed store reserve. Additionally, some of our closed stores were closed prior to our adoption of ASC 420, "Exit or Disposal Cost Obligations." Therefore, if interest rates change, reserves may be increased or decreased. As of March 4, 2017, a 50 basis point variance in the credit adjusted risk free interest rate would have affected pretax income by approximately $0.6 million for fiscal 2017.
Income taxes: We currently have net operating loss ("NOL") carryforwards that can be utilized to offset future income for federal and state tax purposes. These NOLs generate significant deferred tax assets. Realization is dependent on generating sufficient taxable income prior to the expiration of the loss carryforwards.
We regularly review the deferred tax assets for recoverability considering the relative impact of negative and positive evidence including our historical profitability, projected taxable income, the expected timing of the reversals of existing temporary differences and tax planning strategies. The weight given to the potential effect of the negative and positive evidence is commensurate with the extent to which it can be objectively verified. In evaluating the objective evidence that historical results provide, we consider three years of cumulative pretax book income (loss).
We establish a valuation allowance against deferred tax assets when we determine that it is more likely than not that some portion of our deferred tax assets will not be realized. There have been no significant changes in the assumptions used to calculate our valuation allowance over the last three years.
On an ongoing basis, we will continue to monitor our deferred tax assets to ensure their utilization prior to their expiration. If we determine that we would be able to realize our deferred tax assets in the future in excess of their net recorded amount, we would make an adjustment to the deferred tax asset valuation allowance, which would impact the provision for income taxes.
We recognize tax liabilities in accordance with ASC 740, "Income Taxes" and we adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities.
Litigation reserves: We are involved in litigation on an on-going basis. We accrue our best estimate of the probable loss related to legal claims. Such estimates are based upon a combination of litigation and settlement strategies. These estimates are updated as the facts and circumstances of the cases develop and/or change. To the extent additional information arises or our strategies change, it is possible that our best estimate of the probable liability may also change. Changes to these reserves during the last three fiscal years were not material.
Revenue recognition for our Pharmacy Services segment: Our Pharmacy Services segment sells prescription drugs indirectly through our retail pharmacy network and directly through our mail service dispensing pharmacy. We recognize revenues in our Pharmacy Services segment from (i) our mail service dispensing pharmacy and (ii) prescription drugs sold under retail pharmacy network contracts where we are the principal using the gross method at the contract prices negotiated with our clients, primarily employers, insurance companies, unions, government employee groups, health plans, Managed Medicaid plans, Medicare plans, and other sponsors of health benefit plans, and individuals throughout the United States. Revenue from our Pharmacy Services segment includes: (i) the portion of the price the client pays directly to us, net of any volume-related or other discounts paid back to the client, (ii) the price paid to us ("Mail Co-Payments") by individuals included in our clients' benefit plans, (iii) customer copayments made directly to the retail pharmacy network, and (iv) administrative fees. Sales taxes are not included in revenue.
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We recognize revenue in the Pharmacy Services segment when: (i) persuasive evidence that the prescription drug sale has occurred or a contractual arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the seller's price to the buyer is fixed or determinable, and (iv) collectability is reasonably assured. The following revenue recognition policies have been established for the Pharmacy Services segment.
In the majority of its contracts, the Pharmacy Services segment has determined it is the principal due to it: (i) being the primary obligor in the arrangement, (ii) latitude in establishing price, (iii) performs part of the service, (iv) having discretion in supplier selection and v) having involvement in the determination of product or service specifications. The Pharmacy Services segment's obligations under its client contracts for which revenues are reported using the gross method are separate and distinct from its obligations to the third party pharmacies included in its retail pharmacy network contracts. Pursuant to these contracts, the Pharmacy Services segment is contractually required to pay the third party pharmacies in its retail pharmacy network for products sold after payment is received from its clients. The Pharmacy Services segment's responsibilities under its client contracts typically include validating eligibility and coverage levels, communicating the prescription price and the co-payments due to the third party retail pharmacy, identifying possible adverse drug interactions for the pharmacist to address with the prescriber prior to dispensing, suggesting generic alternatives where clinically appropriate and approving the prescription for dispensing. Although the Pharmacy Services segment does not have credit risk with respect to its pharmacy benefit manager operations and retail co-payments, management believes that all of the other applicable indicators of gross revenue reporting are present.
We deduct from our revenues that are generated from prescription drugs sold by third party pharmacies the manufacturers' rebates that are earned by our clients based on their members' utilization of brand-name formulary drugs. For the majority of our clients, we pass these rebates to clients at point-of-sale based on actual claims data and our estimates of the manufacturers' rebates earned by our clients. We base our estimates on the best available data and recent history for the various factors that can affect the amount of rebates earned by the client. We also deduct from our revenues pricing guarantees and guarantees regarding the level of service we will provide to the client or member as well as other payments made to our clients. Because the inputs to most of these estimates are not subject to a high degree of subjectivity or volatility, the effect of adjustments between estimated and actual amounts have not been material to our results of operations or financial condition.
We participate in the federal government's Medicare Part D program as a PDP through our EIC subsidiary. Our net revenues include insurance premiums earned by the PDP, which are determined based on the PDP's annual bid and related contractual arrangements with CMS. The insurance premiums include a beneficiary premium, which is the responsibility of the PDP member, but is subsidized by CMS in the case of low-income members, and a direct premium paid by CMS. Premiums
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collected in advance are initially deferred as accrued expenses and are then recognized ratably as revenue over the period in which members are entitled to receive benefits.
We have recorded estimates of various assets and liabilities arising from our participation in the Medicare Part D program based on information in our claims management and enrollment systems. Significant estimates arising from our participation in the Medicare Part D program include: (i) estimates of low-income cost subsidy, reinsurance amounts and coverage gap discount amounts ultimately payable to or receivable from CMS based on a detailed claims reconciliation, (ii) an estimate of amounts receivable from CMS under a risk-sharing feature of the Medicare Part D program design, referred to as the risk corridor (iii) estimates for claims that have been reported and are in the process of being paid or contested and (iv) our estimate of claims that have been incurred but have not yet been reported. Actual amounts of Medicare Part D-related assets and liabilities could differ significantly from amounts recorded. Historically, the effect of these adjustments has not been material to our results of operations or financial position.
Vendor allowances and purchase discounts for our Pharmacy Services segment: Our Pharmacy Services segment receives purchase discounts on products purchased. Contractual arrangements with vendors, including manufacturers, wholesalers and retail pharmacies, normally provide for the Pharmacy Services segment to receive purchase discounts from established list prices in one, or a combination, of the following forms: (i) a direct discount at the time of purchase or (ii) a discount (or rebate) paid subsequent to dispensing when products are purchased indirectly from a manufacturer (e.g., through a wholesaler or retail pharmacy). These rebates are recognized based on estimates when prescriptions are dispensed and are generally calculated and billed to manufacturers within 30 days of the end of each completed quarter. Historically, the effect of adjustments resulting from the reconciliation of rebates recognized to the amounts billed and collected has not been material to the results of operations. We account for the effect of any such differences as a change in accounting estimate in the period the reconciliation is completed. The Pharmacy Services segment also receives additional discounts under its wholesaler contract. In addition, the Pharmacy Services segment receives fees from pharmaceutical manufacturers for administrative services. Purchase discounts and administrative service fees are recorded as a reduction of cost of revenues.
Adjusted EBITDA, Adjusted Net Income, Adjusted Net Income per Diluted Share and Other Non-GAAP Measures
In addition to net income determined in accordance with GAAP, we use certain non-GAAP measures, such as "Adjusted EBITDA", in assessing our operating performance. We believe the non-GAAP metrics serve as an appropriate measure in evaluating the performance of our business. We define Adjusted EBITDA as net income excluding the impact of income taxes, interest expense, depreciation and amortization, LIFO adjustments, charges or credits for facility closing and impairment, inventory write-downs related to store closings, debt retirements, and other items (including stock-based compensation expense, severance for distribution center closures, gain or loss on sale of assets, and revenue deferrals related to our customer loyalty program). We reference this particular non-GAAP financial measure frequently in our decision-making because it provides supplemental information that facilitates internal comparisons to the historical periods and external comparisons to competitors. In addition, incentive compensation is primarily based on Adjusted EBITDA and we base certain of our forward-looking estimates on Adjusted EBITDA to facilitate quantification of planned business activities and enhance subsequent follow-up with comparisons of actual to planned Adjusted EBITDA.
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The following is a reconciliation of our net income to Adjusted EBITDA for fiscal 2017, 2016 and 2015:
|
March 4, 2017 (53 weeks) |
February 27, 2016 (52 weeks) |
February 28, 2015 (52 weeks) |
|||||||
---|---|---|---|---|---|---|---|---|---|---|
|
(Dollars in thousands) |
|||||||||
Net income |
$ | 4,053 | $ | 165,465 | $ | 2,109,173 | ||||
Interest expense |
431,991 | 449,574 | 397,612 | |||||||
Income tax expense |
29,689 | 139,297 | 158,951 | |||||||
Income tax valuation allowance increase (release) |
14,703 | (26,358 | ) | (1,841,304 | ) | |||||
Depreciation and amortization expense |
568,231 | 509,212 | 416,628 | |||||||
LIFO (credit) charge |
(6,620 | ) | 11,163 | (18,857 | ) | |||||
Lease termination and impairment charges |
55,294 | 48,423 | 41,945 | |||||||
Loss on debt retirements, net |
| 33,205 | 18,512 | |||||||
Other |
39,800 | 72,281 | 40,183 | |||||||
| | | | | | | | | | |
Adjusted EBITDA |
$ | 1,137,141 | $ | 1,402,262 | $ | 1,322,843 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
The following is a reconciliation of our net income to Adjusted Net Income and Adjusted Net Income per Diluted Share for fiscal 2017, 2016 and 2015. Adjusted Net Income is defined as net income excluding the impact of amortization of EnvisionRx intangible assets, merger and acquisition-related costs, loss on debt retirements and LIFO adjustments. We calculate Adjusted Net Income per Diluted Share using our above-referenced definition of Adjusted Net Income. We believe Adjusted Net Income and Adjusted Net Income per Diluted Share serve as appropriate measures to be used in evaluating the performance of our business and help our investors better compare our operating performance over multiple periods. The following is a reconciliation of our net income to our Adjusted Net Income for fiscal 2017, 2016 and 2015:
|
March 4, 2017 (53 weeks) |
February 27, 2016 (52 weeks) |
February 28, 2015 (52 weeks) |
|||||||
---|---|---|---|---|---|---|---|---|---|---|
|
(Dollars in thousands) |
|||||||||
Net income |
$ | 4,053 | $ | 165,465 | $ | 2,109,173 | ||||
Add backIncome tax expense (benefit) |
44,392 | 112,939 | (1,682,353 | ) | ||||||
| | | | | | | | | | |
Income before income taxes |
48,445 | 278,404 | 426,820 | |||||||
Adjustments: |
||||||||||
Amortization of EnvisionRx intangible assets |
83,022 | 55,527 | | |||||||
LIFO (credit) charge |
(6,620 | ) | 11,163 | (18,857 | ) | |||||
Loss on debt retirements, net |
| 33,205 | 18,512 | |||||||
Merger and Acquisition-related costs |
14,066 | 27,482 | 8,309 | |||||||
| | | | | | | | | | |
Adjusted income before income taxes |
138,913 | 405,781 | 434,784 | |||||||
Adjusted income tax expense(a) |
72,096 | 150,545 | 161,740 | |||||||
| | | | | | | | | | |
Adjusted net income |
$ | 66,817 | $ | 255,236 | $ | 273,044 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
Net income per diluted share |
$ | 0.00 | $ | 0.16 | $ | 2.08 | ||||
Adjusted net income per diluted share |
$ | 0.06 | $ | 0.24 | $ | 0.27 |
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In addition to Adjusted EBITDA, Adjusted Net Income and Adjusted Net Income per Diluted Share, we occasionally refer to several other Non-GAAP measures, on a less frequent basis, in order to describe certain components of our business and how we utilize them to describe our results. These measures include but are not limited to Adjusted EBITDA Gross Margin and Gross Profit (gross margin/gross profit excluding non-Adjusted EBITDA items), Adjusted EBITDA SG&A (SG&A expenses excluding non-Adjusted EBITDA items), FIFO Gross Margin and FIFO Gross Profit (gross margin/gross profit before LIFO charges), and Free Cash Flow (Adjusted EBITDA less cash paid for interest, rent on closed stores, capital expenditures, acquisition costs and the change in working capital).
We include these non-GAAP financial measures in our earnings announcements in order to provide transparency to our investors and enable investors to better compare our operating performance with the operating performance of our competitors including with those of our competitors having different capital structures. Adjusted EBITDA, Adjusted Net Income, Adjusted Net Income per Diluted Share or other non-GAAP measures should not be considered in isolation from, and are not intended to represent an alternative measure of, operating results or of cash flows from operating activities, as determined in accordance with GAAP. Our definition of these non-GAAP measures may not be comparable to similarly titled measurements reported by other companies.
Item 7A. 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. Our major market risk exposure is changing interest rates. Increases in interest rates would increase our interest expense. 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. We currently do not have any derivative transactions outstanding.
The table below provides information about our 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 March 4, 2017.
|
2018 | 2019 | 2020 | 2021 | 2022 | Thereafter | Total | Fair Value at March 4, 2017 |
|||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
(Dollars in thousands) |
||||||||||||||||||||||||
Long-term debt, including current portion, excluding capital lease obligations |
|||||||||||||||||||||||||
Fixed Rate |
$ | 90 | $ | | $ | | $ | 902,000 | $ | 810,000 | $ | 2,223,000 | $ | 3,935,090 | $ | 4,152,374 | |||||||||
Average Interest Rate |
7.61 | % | 0.00 | % | 0.00 | % | 9.25 | % | 6.75 | % | 6.38 | % | 7.11 | % | |||||||||||
Variable Rate |
$ | | $ | | $ | 2,430,000 | $ | 470,000 | $ | 500,000 | $ | | $ | 3,400,000 | $ | 3,404,225 | |||||||||
Average Interest Rate |
0.00 | % | 0.00 | % | 2.44 | % | 5.75 | % | 4.88 | % | 0.00 | % | 3.26 | % |
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 could be materially adversely affected. We cannot be assured that any replacement borrowing or equity financing could be successfully completed.
The interest rate on our variable rate borrowings, which include our revolving credit facility, Tranche 1 Term Loan and our Tranche 2 Term Loan, are all based on LIBOR. However, the interest
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rate on our Tranche 1 Term Loan and Tranche 2 Term Loan have a LIBOR floor of 100 basis points. If the market rates of interest for LIBOR changed by 100 basis points as of March 4, 2017, our annual interest expense would change by approximately $32.4 million.
A change in interest rates does not have an impact upon our future earnings and cash flow for fixed-rate debt instruments. As fixed-rate debt matures, however, and if additional debt is acquired to fund the debt repayment, future earnings and cash flow may be affected by changes in interest rates. This effect would be realized in the periods subsequent to the periods when the debt matures. Increases in interest rates would also impact our ability to refinance existing maturities on favorable terms.
Item 8. Financial Statements and Supplementary Data
Our consolidated financial statements and notes thereto are included elsewhere in this report and are incorporated by reference herein. See Item 15 of Part IV.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable
Item 9A. Controls and Procedures
(a) Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective.
(b) Internal Control Over Financial Reporting
Management's Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we have conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in "Internal ControlIntegrated Framework" (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that, as of March 4, 2017, we did not have any material weaknesses in our internal control over financial reporting and our internal control over financial reporting was effective.
Attestation Report of the Independent Registered Public Accounting Firm
The attestation report of our independent registered public accounting firm, Deloitte & Touche LLP, on our internal control over financial reporting is included after the next paragraph.
(c) Changes in Internal Control Over Financial Reporting
There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our fourth fiscal quarter ended March 4, 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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Report of Independent Registered Public Accounting Firm
To
the Board of Directors and Stockholders of
Rite Aid Corporation
Camp Hill, Pennsylvania
We have audited the internal control over financial reporting of Rite Aid Corporation and subsidiaries (the "Company") as of March 4, 2017, based on criteria established in Internal ControlIntegrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 4, 2017, based on the criteria established in Internal ControlIntegrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule
66
as of and for the year ended March 4, 2017 of the Company and our report dated May 3, 2017 expressed an unqualified opinion on those financial statements and financial statement schedule.
/s/
Deloitte & Touche LLP
Philadelphia, Pennsylvania
May 3, 2017
67
None
68
We intend to file with the SEC a definitive proxy statement for our 2017 Annual Meeting of Stockholders, to be held on or before July 17, 2017, pursuant to Regulation 14A not later than 120 days after March 4, 2017. The information required by Part III (Items 10, 11, 12, 13 and 14) is incorporated by reference from that proxy statement.
69
Item 15. Exhibits and Financial Statement Schedule
(a) The consolidated financial statements of the Company and report of the independent registered public accounting firm identified in the following index are included in this report from the individual pages filed as a part of this report:
1. Financial Statements
The following financial statements, report of the independent registered public accounting firm and supplementary data are included herein:
2. Financial Statement Schedule
Schedule IIValuation and Qualifying Accounts
All other schedules are omitted because they are not applicable, not required or the required information is included in the consolidated financial statements or notes thereto.
70
3. Exhibits
Exhibit Numbers |
Description | Incorporation By Reference To | |||
---|---|---|---|---|---|
2.1 | Agreement and Plan of Merger, dated as of October 27, 2015, among Rite Aid Corporation, Walgreens Boots Alliance, Inc. and Victoria Merger Sub, Inc. | Exhibit 2.1 to Form 8-K, filed on October 29, 2015 | |||
2.2 |
Amendment No. 1 to Agreement and Plan of Merger, dated as of January 29, 2017, by and among Rite Aid Corporation, Walgreens Boots Alliance, Inc. and Victoria Merger Sub, Inc. |
Exhibit 2.1 to Form 8-K filed on January 30, 2017 |
|||
2.3 |
Asset Purchase Agreement, dated as of December 19, 2016, by and among Rite Aid Corporation, Walgreens Boots Alliance, Inc., Fred's, Inc. and AFAE, LLC*** |
Filed herewith |
|||
3.1 |
Amended and Restated Certificate of Incorporation, dated January 22, 2014 |
Exhibit 3.1 to Form 10-K, filed on April 23, 2014 |
|||
3.2 |
Amended and Restated By-Laws |
Exhibit 3.2 to Form 10-Q, filed on January 6, 2016 |
|||
4.1 |
Indenture, dated as of February 27, 2012, among Rite Aid Corporation, as issuer, the subsidiary guarantors named therein and The Bank of New York Mellon Trust Company, N.A., as trustee, related to the Company's 9.25% Senior Notes due 2020 |
Exhibit 4.1 to Form 8-K, filed on February 27, 2012 |
|||
4.2 |
First Supplemental Indenture, dated as of May 15, 2012, among Rite Aid Corporation, the subsidiaries named therein and The Bank of New York Mellon Trust Company, N.A. to the Indenture, dated as of February 27, 2012, among Rite Aid Corporation, the subsidiary guarantors named therein and The Bank of New York Trust Company, N.A., related to the Company's 9.25% Senior Notes due 2020 |
Exhibit 4.23 to the Registration Statement on Form S-4, File No. 181651, filed on May 24, 2012 |
|||
4.3 |
Indenture, dated as of August 1, 1993, between Rite Aid Corporation, as issuer, and Morgan Guaranty Trust Company of New York, as trustee, related to the Company's 7.70% Notes due 2027 |
Exhibit 4A to Registration Statement on Form S-3, File No. 033-63794, filed on June 3, 1993 |
|||
4.4 |
Supplemental Indenture, dated as of February 3, 2000, between Rite Aid Corporation and U.S. Bank Trust National Association (as successor trustee to Morgan Guaranty Trust Company of New York) to the Indenture dated as of August 1, 1993, between Rite Aid Corporation and Morgan Guaranty Trust Company of New York, relating to the Company's 7.70% Notes due 2027 |
Exhibit 4.1 to Form 8-K filed on February 7, 2000 |
71
Exhibit Numbers |
Description | Incorporation By Reference To | |||
---|---|---|---|---|---|
4.5 | Indenture, dated as of December 21, 1998, between Rite Aid Corporation, as issuer, and Harris Trust and Savings Bank, as trustee, related to the Company's 6.875% Notes due 2028 | Exhibit 4.1 to Registration Statement on Form S-4, File No. 333-74751, filed on March 19, 1999 | |||
4.6 |
Supplemental Indenture, dated as of February 3, 2000, between Rite Aid Corporation and Harris Trust and Savings Bank to the Indenture, dated December 21, 1998, between Rite Aid Corporation and Harris Trust and Savings Bank, related to the Company's 6.875% Notes due 2028 |
Exhibit 4.4 to Form 8-K, filed on February 7, 2000 |
|||
4.7 |
Indenture, dated as of July 2, 2013, among Rite Aid Corporation, as issuer, the subsidiary guarantors named therein and The Bank of New York Mellon Trust Company, N.A., related to the Company's 6.75% Senior Notes due 2021 |
Exhibit 4.1 to Form 8-K, filed on July 2, 2013 |
|||
4.8 |
Registration Rights Agreement, dated as of February 10, 2015, by and among Rite Aid Corporation, TPG VI Envision, L.P., TPG VI DE BDH, L.P. and Envision Rx Options Holdings Inc. |
Exhibit 10.3 to Form 8-K, filed on February 13, 2015 |
|||
4.9 |
Indenture, dated as of April 2, 2015, among Rite Aid Corporation, as issuer, the subsidiary guarantors named therein and The Bank of New York Mellon Trust Company, N.A., related to the Company's 6.125% Senior Notes due 2023 |
Exhibit 4.1 to Form 8-K, filed on April 2, 2015 |
|||
4.10 |
Registration Rights Agreement, dated as of April 2, 2015, among Rite Aid Corporation, the subsidiary guarantors named therein and Citigroup Global Markets Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Wells Fargo Securities, LLC, Credit Suisse Securities (USA) LLC and Goldman, Sachs & Co., as the initial purchasers of the Company's 6.125% Senior Notes due 2023 |
Exhibit 10.1 to Form 8-K, filed on April 2, 2015 |
|||
10.1 |
2000 Omnibus Equity Plan* |
Included in Proxy Statement dated October 24, 2000 |
|||
10.2 |
2001 Stock Option Plan* |
Exhibit 10.3 to Form 10-K, filed on May 21, 2001 |
|||
10.3 |
2004 Omnibus Equity Plan* |
Exhibit 10.4 to Form 10-K, filed on April 29, 2005 |
|||
10.4 |
2006 Omnibus Equity Plan* |
Exhibit 10 to Form 8-K, filed on January 22, 2007 |
|||
10.5 |
2010 Omnibus Equity Plan* |
Exhibit 10.1 to Form 8-K, filed on June 25, 2010 |
|||
10.6 |
Amendment No. 1, dated September 21, 2010, to the 2010 Omnibus Equity Plan* |
Exhibit 10.7 to Form 10-Q, filed on October 7, 2010 |
72
Exhibit Numbers |
Description | Incorporation By Reference To | |||
---|---|---|---|---|---|
10.7 | Amendment No. 2, dated January 16, 2013, to the 2010 Omnibus Equity Plan* | Exhibit 10.8 to Form 10-K, filed on April 23, 2013 | |||
10.8 |
2012 Omnibus Equity Plan* |
Exhibit 10.1 to Form 8-K, filed on June 25, 2012 |
|||
10.9 |
Amendment No. 1, dated January 16, 2013, to the 2012 Omnibus Equity Plan* |
Exhibit 10.10 to Form 10-K, filed on April 23, 2013 |
|||
10.10 |
2014 Omnibus Equity Plan* |
Exhibit 10.1 to Form 8-K, filed on June 23, 2014 |
|||
10.11 |
Form of Award Agreement* |
Exhibit 10.2 to Form 8-K, filed on May 15, 2012 |
|||
10.12 |
Supplemental Executive Retirement Plan* |
Exhibit 10.6 to Form 10-K, filed on April 28, 2010 |
|||
10.13 |
Executive Incentive Plan for Officers of Rite Aid Corporation* |
Exhibit 10.1 to Form 8-K, filed on February 24, 2012 |
|||
10.14 |
Amended and Restated Employment Agreement by and between Rite Aid Corporation and John T. Standley, dated as of January 21, 2010* |
Exhibit 10.7 to Form 10-K, filed on April 28, 2010 |
|||
10.15 |
Employment Agreement by and between Rite Aid Corporation and Douglas E. Donley, dated as of August 1, 2000* |
Exhibit 10.1 to Form 10-Q, filed on December 22, 2005 |
|||
10.16 |
Amendment No. 1 to Employment Agreement by and between Rite Aid Corporation and Douglas E. Donley, dated as of December 18, 2008* |
Exhibit 10.4 to Form 10-Q, filed on January 7, 2009 |
|||
10.17 |
Rite Aid Corporation Special Executive Retirement Plan* |
Exhibit 10.15 to Form 10-K, filed on April 26, 2004 |
|||
10.18 |
Employment Agreement by and between Rite Aid Corporation and Ken Martindale, dated as of December 3, 2008* |
Exhibit 10.7 to Form 10-Q, filed on January 7, 2009 |
|||
10.19 |
Letter Agreement, dated July 27, 2010, to the Employment Agreement by and between Rite Aid Corporation and Ken Martindale, dated as of December 3, 2008* |
Exhibit 10.6 to Form 10-Q, filed on October 7, 2010 |
|||
10.20 |
Amendment to Employment Agreement by and between Rite Aid Corporation and Kenneth Martindale dated as of October 26, 2015* |
Exhibit 10.4 to Form 10-Q, filed on January 6, 2016 |
|||
10.21 |
Amended and Restated Employment Agreement, dated as of June 23, 2011, between Rite Aid Corporation and Enio A. Montini, Jr.* |
Exhibit 10.1 to Form 10-Q, filed on October 5, 2011 |
|||
10.22 |
Employment Agreement, dated as of March 24, 2014, by and between Rite Aid Corporation and Dedra N. Castle |
Exhibit 10.2 to Form 10-Q, filed on July 3, 2014 |
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Exhibit Numbers |
Description | Incorporation By Reference To | |||
---|---|---|---|---|---|
10.23 | Employment Agreement, dated as of July 24, 2014, by and between Rite Aid Corporation and Darren W. Karst | Exhibit 10.2 to Form 10-Q, filed on October 2, 2014 | |||
10.24 |
Letter Agreement, dated October 26, 2015, to the Employment Agreement by and between Rite Aid Corporation and Darren W. Karst, dated as of July 24, 2014* |
Exhibit 10.1 to Form 8-K, filed on October 28, 2015 |
|||
10.25 |
Employment Agreement by and between Rite Aid Corporation and Jocelyn Konrad dated as of August 18, 2015* |
Exhibit 10.1 to Form 10-Q, filed on January 6, 2016 |
|||
10.26 |
Employment Agreement by and between Rite Aid Corporation and Bryan Everett dated as of June 22, 2015* |
Exhibit 10.2 to Form 10-Q, filed on January 6, 2016 |
|||
10.27 |
Employment Agreement by and between Rite Aid Corporation and David Abelman dated as of August 3, 2015* |
Exhibit 10.3 to Form 10-Q, filed on January 6, 2016 |
|||
10.28 |
Form of Retention Award Agreement |
Exhibit 10.1 to Form 8-K, filed on January 7, 2016 |
|||
10.29 |
Form of December 31, 2015 Retention Award Agreement |
Exhibit 10.2 to Form 8-K, filed on January 7, 2016 |
|||
10.30 |
Amended and Restated Credit Agreement, dated as of June 27, 2001, as amended and restated as of January 13, 2015, among Rite Aid Corporation, the lenders from time to time party thereto and Citicorp North America, Inc., as administrative agent and collateral agent. |
Exhibit 10.1 to Form 8-K, filed on January 14, 2015 |
|||
10.31 |
First Amendment to Amended and Restated Credit Agreement, dated as of February 10, 2015, among Rite Aid Corporation, the lenders signatory thereto and Citicorp North America, Inc., as administrative agent and collateral agent. |
Exhibit 10.1 to Form 8-K, filed on February 13, 2015 |
|||
10.32 |
Credit Agreement, dated as of June 21, 2013, among Rite Aid Corporation, the lenders from time to time party thereto and Citicorp North America, Inc., as administrative agent and collateral agent |
Exhibit 10.1 to Form 8-K, filed on June 21, 2013 |
|||
10.33 |
Credit Agreement, dated as of February 21, 2013, among Rite Aid Corporation, the lenders from time to time party thereto and Citicorp North America, Inc., as administrative agent and collateral agent |
Exhibit 10.2 to Form 8-K, filed on February 21, 2013 |
74
Exhibit Numbers |
Description | Incorporation By Reference To | |||
---|---|---|---|---|---|
10.34 | Amended and Restated Collateral Trust and Intercreditor Agreement, including the related definitions annex, dated as of June 5, 2009, among Rite Aid Corporation, each subsidiary named therein or which becomes a party thereto, Wilmington Trust Company, as collateral trustee, Citicorp North America, Inc., as senior collateral processing agent, The Bank of New York Trust Company, N.A., as trustee under the 2017 7.5% Note Indenture (as defined therein) and The Bank of New York Mellon Trust Company, N.A., as trustee under the 2016 10.375% Note Indenture (as defined therein), and each other Second Priority Representative and Senior Representative which becomes a party thereto | Exhibit 10.3 to Form 8-K, filed on June 11, 2009 | |||
10.35 |
Amended and Restated Senior Subsidiary Guarantee Agreement, dated as of June 5, 2009 among the subsidiary guarantors party thereto and Citicorp North America, Inc., as senior collateral agent |
Exhibit 10.4 to Form 8-K, filed on June 11, 2009 |
|||
10.36 |
Amended and Restated Senior Subsidiary Security Agreement, dated as of June 5, 2009, by the subsidiary guarantors party thereto in favor of the Citicorp North America, Inc., as senior collateral agent |
Exhibit 10.5 to Form 8-K, filed on June 11, 2009 |
|||
10.37 |
Amended and Restated Senior Indemnity, Subrogation and Contribution Agreement, dated as of May 28, 2003, and supplemented as of September 27, 2004, among Rite Aid Corporation, the Subsidiary Guarantors, and Citicorp North America, Inc. and JPMorgan Chase Bank, N.A., as collateral processing co- agents |
Exhibit 4.27 to Form 10-K, filed on April 29, 2008 |
|||
10.38 |
Second Priority Subsidiary Guarantee Agreement, dated as of June 27, 2001, as amended and restated as of May 28, 2003, and as supplemented as of January 5, 2005, among the Subsidiary Guarantors and Wilmington Trust Company, as collateral agent |
Exhibit 4.36 to Form 10-K, filed on April 17, 2009 |
|||
10.39 |
Second Priority Subsidiary Security Agreement, dated as of June 27, 2001, as amended and restated as of May 28, 2003, as supplemented as of January 5, 2005, and as amended in the Reaffirmation Agreement and Amendment dates as of January 11, 2005, by the Subsidiary Guarantors in favor of Wilmington Trust Company, as collateral trustee |
Exhibit 4.37 to Form 10-K, filed on April 17, 2009 |
|||
10.40 |
Amended and Restated Second Priority Indemnity, Subrogation and Contribution Agreement, dated as of May 28, 2003, and as supplemented as of January 5, 2005, among the Subsidiary Guarantors and Wilmington Trust Company, as collateral agent |
Exhibit 4.33 to Form 10-K, filed on April 29, 2008 |
75
Exhibit Numbers |
Description | Incorporation By Reference To | |||
---|---|---|---|---|---|
10.41 | Intercreditor Agreement, dated as of February 18, 2009, by and among Citicorp North America, Inc. and Citicorp North America, Inc., and acknowledged and agreed to by Rite Aid Funding II | Exhibit 10.2 to Form 8-K, filed on February 20, 2009 | |||
10.42 |
Senior Lien Intercreditor Agreement dated as of June 12, 2009, among Rite Aid Corporation, the subsidiary guarantors named therein, Citicorp North America, Inc., as senior collateral agent for the Senior Secured Parties (as defined therein), Citicorp North America, Inc., as senior representative for the Senior Loan Secured Parties (as defined therein), The Bank of New York Mellon Trust Company, N.A., as Senior Representative (as defined therein) for the Initial Additional Senior Debt Parties (as defined therein), and each additional Senior Representative from time to time party thereto |
Exhibit 10.2 to Form 8-K, filed on June 16, 2009 |
|||
11 |
Statement regarding computation of earnings per share (See Note 4 to the consolidated financial statements) |
Filed herewith |
|||
12 |
Statement regarding computation of ratio of earnings to fixed charges |
Filed herewith |
|||
21 |
Subsidiaries of the Registrant |
Filed herewith |
|||
23 |
Consent of Independent Registered Public Accounting Firm |
Filed herewith |
|||
31.1 |
Certification of CEO pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as amended |
Filed herewith |
|||
31.2 |
Certification of CFO pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as amended |
Filed herewith |
|||
32 |
Certification of CEO and CFO pursuant to 18 United States Code, Section 1350, as enacted by Section 906 of the Sarbanes-Oxley Act of 2002 |
Filed herewith |
76
Exhibit Numbers |
Description | Incorporation By Reference To | |||
---|---|---|---|---|---|
101. | The following materials are formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets at March 4, 2017 and February 27, 2016, (ii) Consolidated Statements of Operations for the fiscal years ended March 4, 2017, February 27, 2016, and February 28, 2015, (iii) Consolidated Statements of Comprehensive Income for the fiscal years ended March 4, 2017, February 27, 2016, and February 28, 2015, (iv) Consolidated Statements of Stockholders' Equity for the fiscal years ended March 4, 2017, February 27, 2016, and February 28, 2015, (v) Consolidated Statements of Cash Flows for the fiscal years ended March 4, 2017, February 27, 2016, and February 28, 2015 and (vi) Notes to Consolidated Financial Statements, tagged in detail. |
In reviewing the agreements included as exhibits to this Annual Report on Form 10-K please remember they are included to provide you with information regarding their terms and are not intended to provide any other factual or disclosure information about Rite Aid Corporation, its subsidiaries or the other parties to the agreements. The agreements may contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties have been made solely for the benefit of the other parties to the applicable agreement and:
Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made or at any other time. Additional information about Rite Aid Corporation may be found elsewhere in this report and the Company's other public filings, which are available without charge through the SEC's website at http://www.sec.gov.
77
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the Board of Directors and Stockholders of
Rite Aid Corporation
Camp Hill, Pennsylvania
We have audited the accompanying consolidated balance sheets of Rite Aid Corporation and subsidiaries (the "Company") as of March 4, 2017 and February 27, 2016, and the related consolidated statements of operations, comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended March 4, 2017. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(2). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Rite Aid Corporation and subsidiaries as of March 4, 2017 and February 27, 2016, and the results of their operations and their cash flows for each of the three years in the period ended March 4, 2017, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of March 4, 2017, based on the criteria established in Internal ControlIntegrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated May 3, 2017 expressed an unqualified opinion on the Company's internal control over financial reporting.
/s/ Deloitte & Touche LLP
Philadelphia,
Pennsylvania
May 3, 2017
78
RITE AID CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
|
March 4, 2017 |
February 27, 2016 |
|||||
---|---|---|---|---|---|---|---|
ASSETS |
|||||||
Current assets: |
|||||||
Cash and cash equivalents |
$ | 245,410 | $ | 124,471 | |||
Accounts receivable, net |
1,771,126 | 1,601,008 | |||||
Inventories, net |
2,837,211 | 2,697,104 | |||||
Prepaid expenses and other current assets |
211,541 | 128,144 | |||||
| | | | | | | |
Total current assets |
5,065,288 | 4,550,727 | |||||
Property, plant and equipment, net |
2,251,692 | 2,255,398 | |||||
Goodwill |
1,715,479 | 1,713,475 | |||||
Other intangibles, net |
835,795 | 1,004,379 | |||||
Deferred tax assets |
1,505,564 | 1,539,141 | |||||
Other assets |
219,934 | 213,890 | |||||
| | | | | | | |
Total assets |
$ | 11,593,752 | $ | 11,277,010 | |||
| | | | | | | |
| | | | | | | |
| | | | | | | |
LIABILITIES AND STOCKHOLDERS' EQUITY |
|||||||
Current liabilities: |
|||||||
Current maturities of long-term debt and lease financing obligations |
$ | 21,335 | $ | 26,848 | |||
Accounts payable |
1,613,909 | 1,542,797 | |||||
Accrued salaries, wages and other current liabilities |
1,370,004 | 1,427,250 | |||||
| | | | | | | |
Total current liabilities |
3,005,248 | 2,996,895 | |||||
Long-term debt, less current maturities |
7,263,288 | 6,914,393 | |||||
Lease financing obligations, less current maturities |
44,070 | 52,895 | |||||
Other noncurrent liabilities |
667,076 | 731,399 | |||||
| | | | | | | |
Total liabilities |
10,979,682 | 10,695,582 | |||||
Commitments and contingencies |
| | |||||
Stockholders' equity: |
|||||||
Common stock, par value $1 per share; 1,500,000 shares authorized; shares issued and outstanding 1,053,690 and 1,047,754 |
1,053,690 | 1,047,754 | |||||
Additional paid-in capital |
4,839,854 | 4,822,665 | |||||
Accumulated deficit |
(5,237,157 | ) | (5,241,210 | ) | |||
Accumulated other comprehensive loss |
(42,317 | ) | (47,781 | ) | |||
| | | | | | | |
Total stockholders' equity |
614,070 | 581,428 | |||||
| | | | | | | |
Total liabilities and stockholders' equity |
$ | 11,593,752 | $ | 11,277,010 | |||
| | | | | | | |
| | | | | | | |
| | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
79
RITE AID CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
|
Year Ended | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
March 4, 2017 (53 Weeks) |
February 27, 2016 (52 Weeks) |
February 28, 2015 (52 Weeks) |
|||||||
Revenues |
$ | 32,845,073 | $ | 30,736,657 | $ | 26,528,377 | ||||
Costs and expenses: |
||||||||||
Cost of revenues |
25,071,008 | 22,910,402 | 18,951,645 | |||||||
Selling, general and administrative expenses |
7,242,359 | 7,013,346 | 6,695,642 | |||||||
Lease termination and impairment charges |
55,294 | 48,423 | 41,945 | |||||||
Interest expense |
431,991 | 449,574 | 397,612 | |||||||
Loss on debt retirements, net |
| 33,205 | 18,512 | |||||||
(Gain) loss on sale of assets, net |
(4,024 | ) | 3,303 | (3,799 | ) | |||||
| | | | | | | | | | |
|
32,796,628 | 30,458,253 | 26,101,557 | |||||||
| | | | | | | | | | |
Income before income taxes |
48,445 | 278,404 | 426,820 | |||||||
Income tax expense (benefit) |
44,392 | 112,939 | (1,682,353 | ) | ||||||
| | | | | | | | | | |
Net income |
$ | 4,053 | $ | 165,465 | $ | 2,109,173 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
Computation of income attributable to common stockholders: |
||||||||||
Income attributable to common stockholdersbasic |
4,053 | 165,465 | 2,109,173 | |||||||
Add back-interest on convertible notes |
| | 5,456 | |||||||
| | | | | | | | | | |
Income attributable to common stockholdersdiluted |
$ | 4,053 | $ | 165,465 | $ | 2,114,629 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
Basic income per share |
$ | 0.00 | $ | 0.16 | $ | 2.17 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
Diluted income per share |
$ | 0.00 | $ | 0.16 | $ | 2.08 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
80
RITE AID CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
|
Year Ended | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
March 4, 2017 (53 Weeks) |
February 27, 2016 (52 Weeks) |
February 28, 2015 (52 Weeks) |
|||||||
Net income |
$ | 4,053 | $ | 165,465 | $ | 2,109,173 | ||||
Other comprehensive income (loss): |
||||||||||
Defined benefit pension plans: |
||||||||||
Amortization of prior service cost, net transition obligation and net actuarial losses included in net periodic pension cost, net of $3,600, $(1,681), and $(6,042) tax expense (benefit) |
5,464 | (1,931 | ) | (8,516 | ) | |||||
| | | | | | | | | | |
Total other comprehensive income (loss) |
5,464 | (1,931 | ) | (8,516 | ) | |||||
| | | | | | | | | | |
Comprehensive income |
$ | 9,517 | $ | 163,534 | $ | 2,100,657 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
81
RITE AID CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Years Ended March 4, 2017, February 27, 2016 and February 28, 2015
(In thousands, except per share amounts)
|
Common Stock | |
|
Accumulated Other Comprehensive Loss |
|
||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Additional Paid-In Capital |
Accumulated Deficit |
|
||||||||||||||||
|
Shares | Amount | Total | ||||||||||||||||
BALANCE MARCH 1, 2014 |
971,331 | $ | 971,331 | $ | 4,468,149 | $ | (7,515,848 | ) | $ | (37,334 | ) | $ | (2,113,702 | ) | |||||
Net income |
2,109,173 | 2,109,173 | |||||||||||||||||
Other comprehensive loss: |
|||||||||||||||||||
Changes in Defined Benefit Plans, net of $6,042 tax benefit |
(8,516 | ) | (8,516 | ) | |||||||||||||||
| | | | | | | | | | | | | | | | | | | |
Comprehensive income |
2,100,657 | ||||||||||||||||||
Exchange of restricted shares for taxes |
(2,115 | ) | (2,115 | ) | (13,063 | ) | (15,178 | ) | |||||||||||
Issuance of restricted stock |
3,303 | 3,303 | (3,303 | ) | | ||||||||||||||
Cancellation of restricted stock |
(454 | ) | (454 | ) | 454 | | |||||||||||||
Amortization of restricted stock balance |
12,441 | 12,441 | |||||||||||||||||
Stock-based compensation expense |
10,949 | 10,949 | |||||||||||||||||
Tax benefit from exercise of stock options and restricted stock vesting |
37,772 | 37,772 | |||||||||||||||||
Stock options exercised |
16,485 | 16,485 | 7,612 | 24,097 | |||||||||||||||
Conversion of convertible debt instruments |
8 | 8 | 12 | 20 | |||||||||||||||
| | | | | | | | | | | | | | | | | | | |
BALANCE FEBRUARY 28, 2015 |
988,558 | $ | 988,558 | $ | 4,521,023 | $ | (5,406,675 | ) | $ | (45,850 | ) | $ | 57,056 | ||||||
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
Net income |
165,465 | 165,465 | |||||||||||||||||
Other comprehensive loss: |
|||||||||||||||||||
Changes in Defined Benefit Plans, net of $1,681 tax benefit |
(1,931 | ) | (1,931 | ) | |||||||||||||||
| | | | | | | | | | | | | | | | | | | |
Comprehensive income |
163,534 | ||||||||||||||||||
Exchange of restricted shares for taxes |
(2,045 | ) | (2,045 | ) | (15,461 | ) | (17,506 | ) | |||||||||||
Issuance of restricted stock |
2,751 | 2,751 | (2,751 | ) | | ||||||||||||||
Cancellation of restricted stock |
(420 | ) | (420 | ) | 420 | | |||||||||||||
Amortization of restricted stock balance |
28,342 | 28,342 | |||||||||||||||||
Stock-based compensation expense |
11,164 | 11,164 | |||||||||||||||||
Conversion of convertible debt instruments |
24,762 | 24,762 | 39,327 | 64,089 | |||||||||||||||
Tax benefit from exercise of stock options and restricted stock vesting |
22,466 | 22,466 | |||||||||||||||||
Stock options exercised |
6,394 | 6,394 | 4,982 | 11,376 | |||||||||||||||
Shares issued for EnvisionRx acquisition |
27,754 | 27,754 | 213,153 | 240,907 | |||||||||||||||
| | | | | | | | | | | | | | | | | | | |
BALANCE FEBRUARY 27, 2016 |
1,047,754 | $ | 1,047,754 | $ | 4,822,665 | $ | (5,241,210 | ) | $ | (47,781 | ) | $ | 581,428 | ||||||
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
Net income |
4,053 | 4,053 | |||||||||||||||||
Other comprehensive loss: |
|||||||||||||||||||
Changes in Defined Benefit Plans, net of $3,600 tax expense |
5,464 | 5,464 | |||||||||||||||||
| | | | | | | | | | | | | | | | | | | |
Comprehensive income |
9,517 | ||||||||||||||||||
Exchange of restricted shares for taxes |
(809 | ) | (809 | ) | (5,446 | ) | (6,255 | ) | |||||||||||
Issuance of restricted stock |
3,613 | 3,613 | (3,613 | ) | | ||||||||||||||
Cancellation of restricted stock |
(424 | ) | (424 | ) | 424 | | |||||||||||||
Amortization of restricted stock balance |
12,588 | 12,588 | |||||||||||||||||
Stock-based compensation expense |
9,989 | 9,989 | |||||||||||||||||
Tax benefit from exercise of stock options and restricted stock vesting |
(148 | ) | (148 | ) | |||||||||||||||
Stock options exercised |
3,556 | 3,556 | 3,395 | 6,951 | |||||||||||||||
| | | | | | | | | | | | | | | | | | | |
BALANCE MARCH 4, 2017 |
1,053,690 | $ | 1,053,690 | $ | 4,839,854 | $ | (5,237,157 | ) | $ | (42,317 | ) | $ | 614,070 | ||||||
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
82
RITE AID CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
|
Year Ended | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
March 4, 2017 (53 Weeks) |
February 27, 2016 (52 Weeks) |
February 28, 2015 (52 Weeks) |
|||||||
OPERATING ACTIVITIES: |
||||||||||
Net income |
$ | 4,053 | $ | 165,465 | $ | 2,109,173 | ||||
Adjustments to reconcile to net cash provided by operating activities: |
||||||||||
Depreciation and amortization |
568,231 | 509,212 | 416,628 | |||||||
Lease termination and impairment charges |
55,294 | 48,423 | 41,945 | |||||||
LIFO (credit) charge |
(6,620 | ) | 11,163 | (18,857 | ) | |||||
(Gain) loss on sale of assets, net |
(4,024 | ) | 3,303 | (3,799 | ) | |||||
Stock-based compensation expense |
23,482 | 37,948 | 23,390 | |||||||
Loss on debt retirements, net |
| 33,205 | 18,512 | |||||||
Changes in deferred taxes |
35,038 | 79,488 | (1,726,487 | ) | ||||||
Excess tax benefit on stock options and restricted stock |
(543 | ) | (22,884 | ) | (41,563 | ) | ||||
Changes in operating assets and liabilities: |
||||||||||
Accounts receivable |
(166,765 | ) | 291,659 | (25,902 | ) | |||||
Inventories |
(133,543 | ) |