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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended August 29, 2015

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from               to              

 

Commission File Number: 1-5742

 

RITE AID CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware
(State or other jurisdiction of
incorporation or organization)

 

23-1614034
(I.R.S. Employer
Identification No.)

 

 

 

30 Hunter Lane,
Camp Hill, Pennsylvania

(Address of principal executive offices)

 

17011
(Zip Code)

 

Registrant’s telephone number, including area code: (717) 761-2633.

 

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report):

Not Applicable

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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 x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o
(Do not check if a smaller reporting company)

 

Smaller reporting company o

 

Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange act). Yes o   No x

 

The registrant had 1,046,265,328 shares of its $1.00 par value common stock outstanding as of September 28, 2015.

 

 

 



Table of Contents

 

RITE AID CORPORATION

 

TABLE OF CONTENTS

 

 

Cautionary Statement Regarding Forward-Looking Statements

2

 

PART I
FINANCIAL INFORMATION

 

ITEM 1.

Financial Statements (unaudited):

 

 

Condensed Consolidated Balance Sheets as of August 29, 2015 and February 28, 2015

4

 

Condensed Consolidated Statements of Operations for the Thirteen Week Periods Ended August 29, 2015 and August 30, 2014

5

 

Condensed Consolidated Statements of Comprehensive Income for the Thirteen Week Periods Ended August 29, 2015 and August 30, 2014

6

 

Condensed Consolidated Statements of Operations for the Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

7

 

Condensed Consolidated Statements of Comprehensive Income for the Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

8

 

Condensed Consolidated Statements of Cash Flows for the Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

9

 

Notes to Condensed Consolidated Financial Statements

10

ITEM 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

32

ITEM 3.

Quantitative and Qualitative Disclosures About Market Risk

44

ITEM 4.

Controls and Procedures

45

 

PART II
OTHER INFORMATION

 

ITEM 1.

Legal Proceedings

46

ITEM 1A.

Risk Factors

46

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

49

ITEM 3.

Defaults Upon Senior Securities

49

ITEM 4.

Mine Safety Disclosures

49

ITEM 5.

Other Information

49

ITEM 6.

Exhibits

50

 

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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:

 

·                  our high level of indebtedness;

 

·                  our ability to make interest and principal payments on our debt and satisfy the other covenants contained in our credit facilities and other debt agreements;

 

·                  general economic conditions, inflation and interest rate movements;

 

·                  the continued impact of private and public third party payors reduction in prescription drug reimbursement and their efforts to limit access to payor networks, including mail order;

 

·                  our ability to achieve the benefits of our efforts to reduce the costs of our generic and other drugs;

 

·                  our ability to continue to improve the operating performance of our stores in accordance with our long term strategy;

 

·                  our ability to maintain or grow prescription count and realize front-end sales growth;

 

·                  our ability to hire and retain qualified personnel;

 

·                  competitive pricing pressures, including aggressive promotional activity from our competitors;

 

·                  decisions to close additional stores and distribution centers or undertake additional refinancing activities, which could result in further charges to our operating statement;

 

·                  our ability to manage expenses and working capital;

 

·                  continued consolidation of the drugstore and the pharmacy benefit management (“PBM”) industries;

 

·                  changes in state or federal legislation or regulations, and the continued impact from the ongoing implementation of the Patient Protection and Affordable Care Act as well as other healthcare reform;

 

·                  the outcome of lawsuits and governmental investigations;

 

·                  risks related to compromises of our information or payment systems or unauthorized access to confidential or personal information of our associates or customers;

 

·                  our ability to realize the benefits of our recent acquisition of EnvisionRx (the “Acquisition”);

 

·                  our ability to maintain our current pharmacy services business and obtain new pharmacy services business, including maintaining renewals of expiring contracts, avoiding contract termination rights that may permit certain of our clients to terminate their contracts prior to their expiration and early price renegotiations prior to contract expirations;

 

·                  the continued impact of declining gross margins in the PBM industry due to increased market competition and client demand for lower prices while providing enhanced service offerings,

 

·                  our ability to maintain our current Medicare Part D business and obtain new Medicare Part D business, as a result of the annual Medicare Part D competitive bidding process; and

 

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·                  other risks and uncertainties described from time to time in our filings with the Securities and Exchange Commission (the “SEC”).

 

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 Operations” either included herein or in our Annual Report on Form 10-K for the fiscal year ended February 28, 2015 (the “Fiscal 2015 10-K”) which we filed with the SEC on April 23, 2015, and our Quarterly Report on Form 10-Q for the thirteen weeks ended May 30, 2015 (the “First Quarter 2016 10-Q”) which we filed on June 22, 2015. These documents are available on the SEC’s website at www.sec.gov.

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1.  Financial Statements

 

RITE AID CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

(In thousands, except per share amounts)

 

(unaudited)

 

 

 

August 29, 2015

 

February 28,
2015

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

152,647

 

$

115,899

 

Accounts receivable, net

 

1,872,976

 

980,904

 

Inventories, net of LIFO reserve of $1,009,501 and $997,528

 

2,902,749

 

2,882,980

 

Deferred tax assets

 

17,823

 

17,823

 

Prepaid expenses and other current assets

 

140,939

 

224,152

 

Total current assets

 

5,087,134

 

4,221,758

 

Property, plant and equipment, net

 

2,198,674

 

2,091,369

 

Goodwill

 

1,533,827

 

76,124

 

Other intangibles, net

 

1,225,531

 

421,480

 

Deferred tax assets

 

1,617,311

 

1,766,349

 

Other assets

 

316,754

 

286,172

 

Total assets

 

$

11,979,231

 

$

8,863,252

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current maturities of long-term debt and lease financing obligations

 

$

29,002

 

$

100,376

 

Accounts payable

 

1,594,411

 

1,133,520

 

Accrued salaries, wages and other current liabilities

 

1,703,545

 

1,193,419

 

Deferred tax liabilities

 

57,622

 

57,685

 

Total current liabilities

 

3,384,580

 

2,485,000

 

Long-term debt, less current maturities

 

7,361,079

 

5,483,415

 

Lease financing obligations, less current maturities

 

54,232

 

61,152

 

Other noncurrent liabilities

 

749,637

 

776,629

 

Total liabilities

 

11,549,528

 

8,806,196

 

Commitments and contingencies

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock, par value $1 per share; 1,500,000 shares authorized; shares issued and outstanding 1,045,622 and 988,558

 

1,045,622

 

988,558

 

Additional paid-in capital

 

4,795,106

 

4,521,023

 

Accumulated deficit

 

(5,366,370

)

(5,406,675

)

Accumulated other comprehensive loss

 

(44,655

)

(45,850

)

Total stockholders’ equity

 

429,703

 

57,056

 

Total liabilities and stockholders’ equity

 

$

11,979,231

 

$

8,863,252

 

 

See accompanying notes to condensed consolidated financial statements.

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

(In thousands, except per share amounts)

 

(unaudited)

 

 

 

Thirteen Week Period Ended

 

 

 

August 29, 2015

 

August 30, 2014

 

Revenues

 

$

7,664,776

 

$

6,522,584

 

Costs and expenses:

 

 

 

 

 

Cost of revenues

 

5,742,485

 

4,628,005

 

Selling, general and administrative expenses

 

1,725,826

 

1,640,524

 

Lease termination and impairment charges

 

9,637

 

7,111

 

Interest expense

 

115,410

 

100,950

 

Loss on debt retirements, net

 

33,205

 

 

Loss (gain) on sale of assets, net

 

281

 

(1,715

)

 

 

7,626,844

 

6,374,875

 

Income before income taxes

 

37,932

 

147,709

 

Income tax expense

 

16,463

 

19,860

 

Net income

 

$

21,469

 

$

127,849

 

Computation of income attributable to common stockholders:

 

 

 

 

 

Net income

 

$

21,469

 

$

127,849

 

Add back — interest on convertible notes

 

 

1,364

 

Income attributable to common stockholders—diluted

 

$

21,469

 

$

129,213

 

Basic and diluted income per share

 

$

0.02

 

$

0.13

 

 

See accompanying notes to condensed consolidated financial statements.

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

(In thousands)

 

(unaudited)

 

 

 

Thirteen Week Period Ended

 

 

 

August 29, 2015

 

August 30, 2014

 

Net income

 

$

21,469

 

$

127,849

 

Other comprehensive income:

 

 

 

 

 

Defined benefit pension plans:

 

 

 

 

 

Amortization of prior service cost, net transition obligation and net actuarial losses included in net periodic pension cost, net of $398 and $0 tax expense

 

598

 

660

 

Total other comprehensive income

 

598

 

660

 

Comprehensive income

 

$

22,067

 

$

128,509

 

 

See accompanying notes to condensed consolidated financial statements.

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

(In thousands, except per share amounts)

 

(unaudited)

 

 

 

Twenty-Six Week Period Ended

 

 

 

August 29, 2015

 

August 30, 2014

 

Revenues

 

$

14,312,337

 

$

12,988,115

 

Costs and expenses:

 

 

 

 

 

Cost of revenues

 

10,530,516

 

9,290,557

 

Selling, general and administrative expenses

 

3,425,411

 

3,284,878

 

Lease termination and impairment charges

 

14,659

 

11,959

 

Interest expense

 

239,017

 

201,770

 

Loss on debt retirements, net

 

33,205

 

 

Loss (gain) on sale of assets, net

 

320

 

(2,085

)

 

 

14,243,128

 

12,787,079

 

Income before income taxes

 

69,209

 

201,036

 

Income tax expense

 

28,904

 

31,741

 

Net income

 

$

40,305

 

$

169,295

 

Computation of income attributable to common stockholders:

 

 

 

 

 

Net income

 

$

40,305

 

$

169,295

 

Add back — interest on convertible notes

 

 

2,728

 

Income attributable to common stockholders—diluted

 

$

40,305

 

$

172,023

 

Basic income per share

 

$

0.04

 

$

0.18

 

Diluted income per share

 

$

0.04

 

$

0.17

 

 

See accompanying notes to condensed consolidated financial statements.

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

(In thousands)

 

(unaudited)

 

 

 

Twenty-Six Week Period Ended

 

 

 

August 29, 2015

 

August 30, 2014

 

Net income

 

$

40,305

 

$

169,295

 

Other comprehensive income:

 

 

 

 

 

Defined benefit pension plans:

 

 

 

 

 

Amortization of prior service cost, net transition obligation and net actuarial losses included in net periodic pension cost, net of $796 and $0 tax expense

 

1,195

 

1,319

 

Total other comprehensive income

 

1,195

 

1,319

 

Comprehensive income

 

$

41,500

 

$

170,614

 

 

See accompanying notes to condensed consolidated financial statements.

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(In thousands)

 

(unaudited)

 

 

 

Twenty-Six Week Period Ended

 

 

 

August 29, 2015

 

August 30, 2014

 

Operating activities:

 

 

 

 

 

Net income

 

$

40,305

 

$

169,295

 

Adjustments to reconcile to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

237,348

 

204,589

 

Lease termination and impairment charges

 

14,659

 

11,959

 

LIFO charges

 

11,973

 

3,089

 

Loss (gain) on sale of assets, net

 

320

 

(2,085

)

Stock-based compensation expense

 

16,201

 

9,892

 

Loss on debt retirements, net

 

33,205

 

 

Changes in deferred taxes

 

1,574

 

 

Excess tax benefit on stock options and restricted stock

 

(20,869

)

(27,058

)

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

8,119

 

441

 

Inventories

 

(24,469

)

68,917

 

Accounts payable

 

31,909

 

(26,750

)

Other assets and liabilities, net

 

(8,703

)

(50,058

)

Net cash provided by operating activities

 

341,572

 

362,231

 

Investing activities:

 

 

 

 

 

Payments for property, plant and equipment

 

(271,683

)

(193,633

)

Intangible assets acquired

 

(43,462

)

(40,023

)

Acquisition of businesses, net of cash acquired

 

(1,779,571

)

(69,793

)

Proceeds from dispositions of assets and investments

 

6,081

 

6,102

 

Net cash used in investing activities

 

(2,088,635

)

(297,347

)

Financing activities:

 

 

 

 

 

Proceeds from issuance of long-term debt

 

1,800,000

 

1,152,293

 

Net proceeds from revolver

 

728,000

 

5,000

 

Principal payments on long-term debt

 

(661,217

)

(1,165,623

)

Change in zero balance cash accounts

 

(51,309

)

(57,545

)

Net proceeds from issuance of common stock

 

8,105

 

14,791

 

Financing fees paid for early debt redemption

 

(26,003

)

 

Excess tax benefit on stock options and restricted stock

 

20,869

 

27,058

 

Deferred financing costs paid

 

(34,634

)

(1,506

)

Net cash provided by (used in) financing activities

 

1,783,811

 

(25,532

)

Increase in cash and cash equivalents

 

36,748

 

39,352

 

Cash and cash equivalents, beginning of period

 

115,899

 

146,406

 

Cash and cash equivalents, end of period

 

$

152,647

 

$

185,758

 

Supplementary cash flow data:

 

 

 

 

 

Cash paid for interest (net of capitalized amounts of $87 and $90, respectively)

 

$

170,053

 

$

192,319

 

Cash payments of income taxes, net of refunds

 

$

3,154

 

$

4,118

 

Equipment financed under capital leases

 

$

1,271

 

$

3,925

 

Equipment received for noncash consideration

 

$

2,011

 

$

1,337

 

Stock consideration issued in connection with business acquisitions

 

$

240,907

 

$

 

Conversion of the 8.5% convertible notes to common stock

 

$

64,089

 

$

 

Gross borrowings from revolver

 

$

2,904,000

 

$

1,556,000

 

Gross payments to revolver

 

$

2,176,000

 

$

1,551,000

 

 

See accompanying notes to condensed consolidated financial statements.

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

1. Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X and therefore do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete annual financial statements. The accompanying financial information reflects all adjustments which are of a recurring nature and, in the opinion of management, are necessary for a fair presentation of the results for the interim periods. The results of operations for the thirteen and twenty-six week periods ended August 29, 2015 are not necessarily indicative of the results to be expected for the full year. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Rite Aid Corporation and Subsidiaries (the “Company”) Fiscal 2015 10-K.

 

In addition to the significant accounting policies discussed in the Company’s Fiscal 2015 10-K, the Company has added the following significant accounting policies as a result of its June 24, 2015 acquisition of EnvisionRx (the “Acquisition”), and the related addition of the new Pharmacy Services segment (please see Note 2. Acquisition and Note 13. Segment Reporting for additional details):

 

Revenue Recognition — Pharmacy Services Segment

 

The Pharmacy Services segment (“Pharmacy Services”) sells prescription drugs indirectly through its retail pharmacy network and directly through its mail service dispensing pharmacy. The Pharmacy Services segment recognizes revenue from prescription drugs sold by (i) its mail service dispensing pharmacy and (ii) under retail pharmacy network contracts where it is the principal using the gross method at the contract prices negotiated with its 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. Revenues include: (i) the portion of the price the client pays directly to the Pharmacy Services segment, net of any volume-related or other discounts paid back to the client (see “Drug Discounts” on the following page), (ii) the price paid to the Pharmacy Services segment by client plan members for mail order prescriptions (“Mail Co-Payments”), and (iii) administrative fees. Sales taxes are not included in revenue. Revenue is recognized 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:

 

·                  Revenues generated from prescription drugs sold by third party pharmacies in the Pharmacy Services segment’s retail pharmacy network and associated administrative fees are recognized at the Pharmacy Services segment’s point-of-sale, which is when the claim is adjudicated by the Pharmacy Services segment’s online claims processing system.

·                  Revenues generated from prescription drugs sold by the Pharmacy Services segment’s mail service dispensing pharmacy are recognized when the prescription is delivered. At the time of delivery, the Pharmacy Services segment has performed substantially all of its obligations under its client contracts and does not experience a significant level of returns or reshipments.

·                  Revenues generated from administrative fees based on membership or claims volume are recognized monthly upon active membership in the plan or actual claims volume.

 

The Pharmacy Services segment determines whether it is the principal or agent for its retail pharmacy network transactions on a contract by contract basis. 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) having discretion in supplier selection, (iii) having involvement in the determination of product or service specifications, and (iv) having credit risk. 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, regardless of whether the

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

Pharmacy Services segment is paid by 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 retail co-payments, management believes that all of the other applicable indicators of gross revenue reporting are present.

 

Drug Discounts — The Pharmacy Services segment deducts from its revenues that are generated from prescription drugs sold by third party pharmacies any rebates, inclusive of discounts and fees, earned by its clients. Rebates are paid to clients in accordance with the terms of client contracts.

 

Medicare Part D — The Pharmacy Services segment, through its Envision Insurance Company (“EIC”) subsidiary, participates in the federal government’s Medicare Part D program as a Prescription Drug Plan (“PDP”). Net revenues include insurance premiums earned by the PDP, which are determined based on the PDP’s annual bid and related contractual arrangements with the Centers for Medicare and Medicaid Services (“CMS”). The insurance premiums include a direct premium paid by CMS and a beneficiary premium, which is the responsibility of the PDP member, but is subsidized by CMS in the case of low-income members. Premiums collected in advance are initially deferred in accrued expenses and are then recognized in net revenues over the period in which members are entitled to receive benefits.

 

See Note 13 for additional information about the revenues of the Company’s business segments.

 

Cost of Revenues — Pharmacy Services Segment

 

The Pharmacy Services segment’s cost of revenues includes the cost of prescription drugs sold during the reporting period indirectly through its retail pharmacy network and directly through its mail service dispensing pharmacy.  The cost of prescription drugs sold component of cost of revenues includes: (i) the cost of the prescription drugs purchased from manufacturers or distributors and shipped to members in clients’ benefit plans from the Pharmacy Services segment’s mail service dispensing pharmacy, net of any volume-related or other discounts (see “Vendor allowances and purchase discounts” below) and (ii) the cost of prescription drugs sold through the Pharmacy Services segment’s retail pharmacy network under contracts where it is the principal, net of any volume-related or other discounts.

 

As a result of the Acquisition, and the related addition of the Pharmacy Services segment, the Company now refers to its cost of goods sold as its 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.

 

See Note 13 for additional information about the cost of revenues of the Company’s business segments.

 

Vendor Allowances and Purchase Discounts — Pharmacy Services Segment

 

The Company accounts for vendor allowances and purchase discounts as follows:

 

The Pharmacy Services segment receives purchase discounts on products purchased. The Pharmacy Services segment’s 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 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 Pharmacy Services segment’s results of operations. The Pharmacy Services segment accounts 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 contracts.  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”.

 

New Accounting Pronouncements

 

In May 2013, the FASB issued a proposed Accounting Standards Update, Leases (Topic 842): a revision of the 2010 proposed Accounting Standards Update, Leases (Topic 840), that would require an entity to recognize assets and liabilities arising

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

under lease contracts on the balance sheet. The proposed standard, as currently drafted, will have a material impact on the Company’s reported results of operations and financial position.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. This ASU supersedes the revenue recognition requirements in Accounting Standards Codification 605—Revenue Recognition and most industry-specific guidance throughout the Codification. The standard requires that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. This ASU is effective for fiscal years beginning after December 15, 2017, and for interim periods within those fiscal years. The Company is in the process of assessing the impact of the adoption of ASU 2014-09 on its financial position, results of operations and cash flows.

 

In February 2015, the FASB issued ASU No. 2015-02, Consolidation—Amendments to the Consolidation Analysis (Topic 810). This ASU requires reporting entities to reevaluate whether they should consolidate certain legal entities under the revised consolidation model. This standard modifies the evaluation of whether limited partnerships and similar legal entities are variable interest entities (VIEs), eliminates the presumption that a general partner should consolidate a limited partnership, and affects the consolidation analysis of reporting entities that are involved with VIEs, especially those that have fee arrangements and related party relationships. This ASU is effective for fiscal years beginning after December 15, 2015, and for interim periods within those fiscal years. The Company is in the process of assessing the impact of the adoption of ASU 2015-02 on its financial position, results of operations and cash flows.

 

In April 2015, the FASB issued ASU No. 2015-03, Interest—Imputation of Interest (Subtopic 835-30). This ASU simplifies the presentation of debt issuance costs by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct reduction from the carrying amount of the debt liability, which is consistent with the treatment of debt discounts. The new guidance should be applied on a retrospective basis, and upon transition, an entity is required to comply with the applicable disclosures necessary for a change in accounting principle. This ASU is effective for fiscal years beginning after December 15, 2015, and for interim periods within those fiscal years. The Company is in the process of assessing the impact of the adoption of ASU 2015-03 on its financial position.

 

In July 2015, the FASB issued ASU No. 2015-12, Plan Accounting—Defined Benefit Pension Plans (Topic 960), Defined Contribution Pension Plans (Topic 962) Health and Welfare Benefit Plans (Topic 965). There are three parts to the ASU that aim to simplify the accounting and presentation of plan accounting. Part I of this ASU requires fully benefit-responsive investment contracts to be measured at contract value instead of the current fair value measurement. Part II of this ASU requires investments (both participant-directed and nonparticipant-directed investments) of employee benefit plans be grouped only by general type, eliminating the need to disaggregate the investments in multiple ways. Part III of this ASU provides a similar measurement date practical expedient for employee benefit plans as available in ASU No. 2015-04, which allows employers to measure defined benefit plan assets on a month-end date that is nearest to the year’s fiscal year-end when the fiscal period does not coincide with a month-end. Parts I and II of the new guidance should be applied on a retrospective basis. Part III of the new guidance should be applied on a prospective basis. This ASU is effective for fiscal years beginning after December 15, 2015, and for interim periods within those fiscal years. The Company is in the process of assessing the impact of the adoption of ASU 2015-12 on its financial position and results of operations.

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

2. Acquisition

 

On June 24, 2015, the Company completed its previously announced acquisition of TPG VI Envision BL, LLC and Envision Topco Holdings, LLC (“EnvisionRx”), pursuant to the terms of an agreement (“Agreement”) dated February 10, 2015. EnvisionRx, which was a portfolio company of TPG Capital L.P. prior to its acquisition by the Company, is a full-service pharmacy services provider. EnvisionRx provides both transparent and traditional pharmacy benefit manager (“PBM”) options through its EnvisionRx and MedTrak PBMs, respectively. EnvisionRx also offers fully integrated mail-order and specialty pharmacy services through Orchard Pharmaceutical Services; 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 is headquartered in Twinsburg, Ohio and operates as 100 percent owned subsidiary of the Company.

 

Pursuant to the terms of the Agreement, as consideration for the Acquisition, the Company paid $1,883,405 in cash and issued 27,754 shares of Rite Aid common stock. The Company financed the cash portion of the Acquisition with borrowings under its senior secured revolving credit facility, and the net proceeds from the April 2, 2015 issuance of $1,800,000 aggregate principal amount of 6.125% senior notes due 2023 (the “6.125% Notes”). The consideration associated with the common stock was $240,907 based on a stock price of $8.68 per share, representing the closing price of the Company’s common stock on the closing date of the Acquisition. The closing balance sheet has not yet been finalized and therefore, the final purchase price and related purchase price allocation of the Acquisition is subject to change.

 

The Company’s consolidated financial statements for the thirteen and twenty-six week periods ended August 29, 2015 include EnvisionRx results of operations from the Acquisition date of June 24, 2015 through August 29, 2015 (please see Note 13. Segment Reporting for the Pharmacy Services segment results included within the consolidated financial statements for the thirteen and twenty-six week periods ended August 29, 2015, which reflects the results of EnvisionRx). The Company’s financial statements reflect preliminary purchase accounting adjustments in accordance with ASC 805 “Business Combinations”, whereby the purchase price was preliminarily allocated to the assets acquired and liabilities assumed based upon their estimated fair values on the Acquisition date.

 

The following allocation of the purchase price and the estimated transaction costs is preliminary and is based on information available to the Company’s management at the time the consolidated financial statements were prepared. Accordingly, the allocation is subject to change and the impact of such changes may be material.

 

Preliminary purchase price

 

 

 

Cash consideration

 

$

1,883,405

 

Stock consideration

 

240,907

 

Total

 

$

2,124,312

 

Preliminary purchase price allocation

 

 

 

Cash and cash equivalents

 

$

103,834

 

Accounts receivable

 

900,473

 

Inventories

 

7,276

 

Deferred tax assets

 

516

 

Prepaid expenses and other current assets

 

13,820

 

Total current assets

 

1,025,919

 

Property and equipment

 

13,196

 

Intangible assets(1)

 

842,585

 

Goodwill

 

1,457,703

 

Other assets

 

8,919

 

Total assets acquired

 

3,348,322

 

Accounts payable

 

491,672

 

Reinsurance funds held

 

381,225

 

Other current liabilities(2)

 

207,723

 

Total current liabilities

 

1,080,620

 

Other long term liabilities(3)

 

143,390

 

Total liabilities assumed

 

1,224,010

 

Net assets acquired

 

$

2,124,312

 

 


(1)            Intangible assets are recorded at estimated fair value, as determined by management based on available information which includes a preliminary valuation prepared by an independent third party. The fair values assigned to identifiable intangible assets were determined through the use of the income approach, specifically the relief from royalty and the multi-period excess

 

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Table of Contents

 

RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

earnings methods.  The major assumptions used in arriving at the estimated identifiable intangible asset values included management’s preliminary estimates of future cash flows, discounted at an appropriate rate of return which are based on the weighted average cost of capital for both the Company and other market participants, projected customer attrition rates, as well as applicable royalty rates for comparable assets.  The useful lives for intangible assets were determined based upon the remaining useful economic lives of the intangible assets that are expected to contribute directly or indirectly to future cash flows.  The estimated fair value of intangible assets and related useful lives as included in the preliminary purchase price allocation include:

 

 

 

Estimated Fair
Value

 

Estimated Useful
Life
(In Years)

 

Customer relationships

 

$

585,500

 

17

 

CMS license

 

108,000

 

25

 

Claims adjudication and other developed software

 

59,500

 

7

 

Trademarks

 

15,600

 

10

 

Backlog

 

12,500

 

3

 

Other

 

17,485

 

5

 

Trademarks

 

44,000

 

Indefinite

 

Total

 

$

842,585

 

 

 

 

(2)            Other current liabilities includes $116,500 due to TPG under the terms of the Agreement, representing the amounts due to EnvisionRx from CMS, less corresponding amounts due to various reinsurance providers under certain reinsurance programs, for CMS activities that relate to the year ended December 31, 2014.

 

(3)            Primarily relates to deferred tax liabilities.

 

The above goodwill represents future economic benefits expected to be recognized from the Company’s expansion into the pharmacy services market, as well as expected future synergies and operating efficiencies from combining operations with EnvisionRx. Goodwill resulting from the Acquisition has been allocated to the Pharmacy Services segment and should be deductible for tax purposes. At the time the financial statements were issued, initial accounting for the business combination related to tax matters were preliminary and may be adjusted during the measurement period.

 

During the thirteen and twenty-six weeks periods ended August 29, 2015, acquisition costs of $9,613, and $27,072, respectively, were expensed as incurred. The following unaudited pro forma combined financial data gives effect to the Acquisition as if it had occurred as of March 1, 2014.

 

These unaudited pro forma combined results have been prepared by combining the historical results of the Company and historical results of EnvisionRx. The unaudited pro forma combined financial data for all periods presented were adjusted to give effect to proforma events that 1) are directly attributable to the aforementioned transaction, 2) factually supportable, and 3) expected to have a continuing impact on the consolidated results of operations.  Specifically, these adjustments reflect:

 

·                  Incremental interest expense relating to the $1,800,000 6.125% Notes issued on April 2, 2015, the net proceeds of which were used finance the cash portion of the Acquisition.

 

·                  Incremental amortization resulting from increased fair value of the identifiable intangible assets as noted in the preliminary purchase price allocation.

 

·                  Removal of costs incurred in connection with the Acquisition by both the Company and EnvisionRx, including bridge loan commitment fees of $15,375.

 

·                  Debt extinguishment charges incurred by EnvisionRx.

 

·                  Inclusion of the 27,754 shares of Rite Aid common stock issued to fund the stock portion of the purchase price in the basic and diluted share calculation.

 

The unaudited combined pro forma results do not include any incremental cost savings that may result from the integration. The adjustments are based on information available to the Company at this time. Accordingly, the adjustments are subject to change and the impact of such changes may be material.

 

The unaudited combined pro forma information is for informational purposes only.  The pro forma information is not necessarily

 

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Table of Contents

 

RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

indicative of what the combined company’s results actually would have been had the Acquisition been completed as of the beginning of the periods as indicated.  In addition, the unaudited pro forma information does not purport to project the future results of the combined company.

 

 

 

Thirteen week
Periods Ended

 

Twenty-Six week
Periods Ended

 

 

 

August 29,
2015

 

August 30,
2014

 

August 29,
2015

 

August 30,
2014

 

 

 

Pro forma

 

Pro forma

 

Pro forma

 

Pro forma

 

Net revenues as reported

 

$

7,664,776

 

$

6,522,584

 

$

14,312,337

 

$

12,988,115

 

EnvisionRx revenue, prior to the acquisition

 

364,159

 

997,946

 

1,735,635

 

1,986,324

 

Less pre-acquisition intercompany revenue

 

(23,777

)

(65,511

)

(104,731

)

(131,413

)

Pro forma combined revenues

 

$

8,005,158

 

$

7,455,019

 

$

15,943,241

 

$

14,843,026

 

 

 

 

 

 

 

 

 

 

 

Net income as reported

 

$

21,469

 

$

127,849

 

$

40,305

 

$

169,295

 

EnvisionRx net income (loss) before income taxes, prior to the acquisition

 

(56,544

)

3,467

 

(45,307

)

7,352

 

Incremental interest expense on the 6.125% Notes issued on April 2, 2015

 

 

(28,852

)

(11,097

)

(57,703

)

Incremental amortization resulting from fair value adjustments of the identifiable intangible assets

 

(3,778

)

(15,179

)

(16,509

)

(26,530

)

Transaction expenses incurred by both the Company and EnvisionRx

 

36,754

 

 

55,864

 

 

Debt extinguishment charges incurred by EnvisionRx

 

31,601

 

 

31,601

 

 

Income tax expense relating to pro forma adjustments

 

(3,294

)

 

(5,966

)

 

Pro forma net income

 

$

26,208

 

$

87,285

 

$

48,891

 

$

92,414

 

 

 

 

 

 

 

 

 

 

 

Basic income per share

 

$

0.03

 

$

0.09

 

$

0.05

 

$

0.09

 

Diluted income per share

 

$

0.02

 

$

0.08

 

$

0.05

 

$

0.09

 

 

3. Income Per Share

 

Basic income per share is computed by dividing income available to common stockholders by the weighted average number of shares of common stock outstanding for the period. Diluted income per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the income of the Company subject to anti-dilution limitations.

 

 

 

Thirteen Week Period
Ended

 

Twenty-Six Week Period
Ended

 

 

 

August 29,
2015

 

August 30,
2014

 

August 29,
2015

 

August 30,
2014

 

Numerator for income per share:

 

 

 

 

 

 

 

 

 

Net income

 

$

21,469

 

$

127,849

 

$

40,305

 

$

169,295

 

Add back—interest on convertible notes

 

 

1,364

 

 

2,728

 

Income attributable to common stockholders—diluted

 

$

21,469

 

$

129,213

 

$

40,305

 

$

172,023

 

Denominator:

 

 

 

 

 

 

 

 

 

Basic weighted average shares

 

1,029,793

 

970,664

 

1,008,242

 

966,997

 

Outstanding options and restricted shares, net

 

19,341

 

26,132

 

18,959

 

26,141

 

Convertible notes

 

 

24,796

 

 

24,796

 

Diluted weighted average shares

 

1,049,134

 

1,021,592

 

1,027,201

 

1,017,934

 

Basic income per share

 

$

0.02

 

$

0.13

 

$

0.04

 

$

0.18

 

Diluted income per share

 

$

0.02

 

$

0.13

 

$

0.04

 

$

0.17

 

 

15



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RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

Due to their antidilutive effect, the following potential common shares have been excluded from the computation of diluted income per share as of August 29, 2015 and August 30, 2014:

 

 

 

Thirteen Week Period
Ended

 

Twenty-Six Week Period
Ended

 

 

 

August 29,
2015

 

August 30,
2014

 

August 29,
2015

 

August 30,
2014

 

Stock options

 

2,893

 

2,836

 

2,893

 

2,836

 

 

 

2,893

 

2,836

 

2,893

 

2,836

 

 

During May 2015, $64,089 of the Company’s 8.5% convertible notes due 2015 were converted into 24,762 shares of common stock, pursuant to their terms.

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

4. Lease Termination and Impairment Charges

 

Lease termination and impairment charges consist of amounts as follows:

 

 

 

Thirteen Week Period
Ended

 

Twenty-Six Week Period
Ended

 

 

 

August 29,
2015

 

August 30,
2014

 

August 29,
2015

 

August 30,
2014

 

Impairment charges

 

$

5

 

$

132

 

$

278

 

$

283

 

Lease termination charges

 

9,632

 

6,979

 

14,381

 

11,676

 

 

 

$

9,637

 

$

7,111

 

$

14,659

 

$

11,959

 

 

Impairment Charges

 

These amounts include the write-down of long-lived assets at locations that were assessed for impairment because of management’s intention to relocate or close the location or because of changes in circumstances that indicated the carrying value of an asset may not be recoverable.

 

Lease Termination Charges

 

As part of the Company’s ongoing business activities, the Company assesses stores and distribution centers for potential closure or relocation. Decisions to close or relocate stores or distribution centers in future periods would result in lease termination charges, lease exit costs and inventory liquidation charges, as well as impairment of assets at these locations. The following table reflects the closed store and distribution center charges that relate to new closures, changes in assumptions and interest accretion:

 

 

 

Thirteen Week Period
Ended

 

Twenty-Six Week Period
Ended

 

 

 

August 29,
2015

 

August 30,
2014

 

August 29,
2015

 

August 30,
2014

 

Balance—beginning of period

 

$

230,803

 

$

270,322

 

$

241,047

 

$

284,270

 

Provision for present value of noncancellable lease payments of closed stores

 

4,426

 

294

 

5,972

 

436

 

Changes in assumptions about future sublease income, terminations and changes in interest rates

 

1,005

 

1,844

 

434

 

1,417

 

Interest accretion

 

4,217

 

4,845

 

8,520

 

9,827

 

Cash payments, net of sublease income

 

(16,784

)

(16,175

)

(32,306

)

(34,820

)

Balance—end of period

 

$

223,667

 

$

261,130

 

$

223,667

 

$

261,130

 

 

5. Fair Value Measurements

 

The Company utilizes the three-level valuation hierarchy for the recognition and disclosure of fair value measurements. The categorization of assets and liabilities within this hierarchy is based upon the lowest level of input that is significant to the measurement of fair value. The three levels of the hierarchy consist of the following:

 

·                  Level 1—Inputs to the valuation methodology are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

 

·                  Level 2—Inputs to the valuation methodology are quoted prices for similar assets and liabilities in active markets, quoted prices in markets that are not active or inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the instrument.

 

·                  Level 3—Inputs to the valuation methodology are unobservable inputs based upon management’s best estimate of inputs market participants could use in pricing the asset or liability at the measurement date, including assumptions about risk.

 

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Table of Contents

 

RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

Non-Financial Assets Measured on a Non-Recurring Basis

 

Long-lived non-financial assets are measured at fair value on a nonrecurring basis for purposes of calculating impairment using Level 2 and Level 3 inputs as defined in the fair value hierarchy. The fair value of long-lived assets using Level 2 inputs is determined by evaluating the current economic conditions in the geographic area for similar use assets. The fair value of long-lived assets using Level 3 inputs is determined by estimating the amount and timing of net future cash flows (which are unobservable inputs) and discounting them using a risk-adjusted rate of interest (which is Level 1). The Company estimates future cash flows based on its experience and knowledge of the market in which the store is located. Significant increases or decreases in actual cash flows may result in valuation changes. During the twenty-six week period ended August 29, 2015, long-lived assets from continuing operations with a carrying value of $2,193, primarily store assets, were written down to their fair value of $1,915, resulting in an impairment charge of $278 of which $5 relates to the thirteen week period ended August 29, 2015. During the twenty-six week period ended August 30, 2014, long-lived assets from continuing operations with a carrying value of $1,849, primarily store assets, were written down to their fair value of $1,566, resulting in an impairment charge of $283 of which $132 relates to the thirteen-week period ended August 30, 2014. 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.

 

The following table presents fair values for those assets measured at fair value on a non-recurring basis at August 29, 2015 and August 30, 2014:

 

Fair Value Measurement Using

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total as of
August 29,
2015

 

Long-lived assets held for use

 

$

 

$

 

$

1,726

 

$

1,726

 

Long-lived assets held for sale

 

$

 

$

 

$

189

 

$

189

 

Total

 

$

 

$

 

$

1,915

 

$

1,915

 

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total as of
August 30,
2014

 

Long-lived assets held for use

 

$

 

$

 

$

1,566

 

$

1,566

 

Long-lived assets held for sale

 

$

 

$

 

$

 

$

 

Total

 

$

 

$

 

$

1,566

 

$

1,566

 

 

As of August 29, 2015 and August 30, 2014, the Company did not have any financial assets measured on a recurring basis.

 

Other Financial Instruments

 

Financial instruments other than long-term indebtedness include cash and cash equivalents, accounts receivable and accounts payable. These instruments are recorded at book value, which we believe approximate their fair values due to their short term nature.  In addition, the Company has $6,598 of investments, carried at amortized cost as these investments are being held to maturity, which are included as a component of other assets as of August 29, 2015.  The Company believes the carrying value of these investments approximates their fair value.

 

The fair value for LIBOR-based borrowings under the Company’s senior secured credit facility and first and second lien term loans are estimated based on the quoted market price of the financial instrument which is considered Level 1 of the fair value hierarchy. The fair values of substantially all of the Company’s other long-term indebtedness are estimated based on quoted market prices of the financial instruments which are considered Level 1 of the fair value hierarchy. The carrying amount and estimated fair value of the Company’s total long-term indebtedness was $7,361,170 and $7,508,010, respectively, as of August 29, 2015. There were no outstanding derivative financial instruments as of August 29, 2015 and February 28, 2015.

 

6. Income Taxes

 

The Company recorded an income tax expense of $16,463 and $19,860 for the thirteen week periods ended August 29, 2015 and August 30, 2014, respectively, and an income tax expense of $28,904 and $31,741 for the twenty-six week periods ended August 29, 2015 and August 30, 2014, respectively. The income tax expense for the thirteen and twenty-six week periods ended August 29, 2015 was based on an estimated effective tax rate of 43.4% and 41.8%, respectively.  The income tax expense for the thirteen and

 

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Table of Contents

 

RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

twenty-six week periods ended August 30, 2014 was primarily attributable to an increase in the deferred tax valuation allowance to offset the windfall tax benefits recorded in Additional Paid in Capital (“APIC”) pursuant to the tax law ordering approach.

 

The Company recognizes tax liabilities in accordance with the guidance for uncertain tax positions and management adjusts these liabilities with changes in judgment 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 the current estimate of the tax liabilities.

 

While it is expected that the amount of unrecognized tax benefits will change in the next twelve months, the Company does not expect the change to have a significant impact on the results of operations or the financial position of the Company.

 

The Company regularly evaluates valuation allowances established for deferred tax assets for which future realization is uncertain.  Management will continue to monitor all available evidence related to the net deferred tax assets that may change the most recent assessment, including events that have occurred or are anticipated to occur. As a result of the Company’s historical operating performance and the more favorable near term outlook for profitability, the Company released $1,841,304 of valuation allowance in the fourth quarter of fiscal year 2015. The Company continues to maintain a valuation allowance against net deferred tax assets of $231,683 and $231,679, which relates primarily to state deferred tax assets at August 29, 2015 and February 28, 2015, respectively.

 

7. Medicare Part D

 

The Company offers Medicare Part D benefits through EIC, which has contracted with CMS to be a PDP and, pursuant to the Medicare Prescription Drug, Improvement and Modernization Act of 2003, must be a risk-bearing entity regulated under state insurance laws or similar statutes.

 

EIC is a licensed domestic insurance company under the applicable laws and regulations. Pursuant to these laws and regulations, EIC must file quarterly and annual reports with the National Association of Insurance Commissioners (“NAIC”) and certain state regulators, must maintain certain minimum amounts of capital and surplus under formulas established by certain states and must, in certain circumstances, request and receive the approval of certain state regulators before making dividend payments or other capital distributions to the Company. The Company does not believe these limitations on dividends and distributions materially impact its financial position.  EIC is subject to minimum capital and surplus requirements in certain states.  The minimum amount of capital and surplus required to satisfy regulatory requirements in these states is $44,400 as of August 29, 2015.  EIC was in excess of the minimum required amounts in these states as of August 29, 2015.

 

The Company has recorded estimates of various assets and liabilities arising from its participation in the Medicare Part D program based on information in its claims management and enrollment systems. Significant estimates arising from its participation in this program include: (i) estimates of low-income cost subsidies, reinsurance amounts, and coverage gap discount amounts ultimately payable to CMS based on a detailed claims reconciliation that will occur in the following year; (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 and (iii) estimates for claims that have been reported and are in the process of being paid or contested and for our estimate of claims that have been incurred but have not yet been reported.

 

As of August 29, 2015, accounts receivable, net included $573,348 due from CMS and accrued salaries, wages and other current liabilities included $394,197 of EIC liabilities under certain reinsurance contracts.  EIC limits its exposure to loss and recovers a portion of benefits paid by utilizing quota-share reinsurance with a commercial reinsurance company.   Additionally, as of August 29, 2015, accrued salaries, wages and other current liabilities included $116,500 due to TPG under the terms of the Agreement, which represents the amounts due to EnvisionRx from CMS, less corresponding amounts due to various reinsurance providers under certain reinsurance programs, for CMS activities that relate to the year ended December 31, 2014.

 

8. Goodwill and Other Intangible Assets

 

Goodwill and indefinitely-lived intangible assets, such as certain trademarks acquired in connection with acquisition transactions, are not amortized, but are instead evaluated for impairment on an annual basis at the end of the fiscal year, or more frequently if events or circumstances indicate that impairment may be more likely. During the twenty-six weeks ended August 29, 2015 and the fifty-two weeks ended February 28, 2015, no impairment charges have been taken against the Company’s goodwill. During the twenty-six weeks ended August 29, 2015, no impairment charges have been taken against the Company’s indefinitely-lived intangible assets. Below is a summary of the changes in the carrying amount of goodwill for the twenty-six week period ended August 29, 2015:

 

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Table of Contents

 

RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

 

 

August 29, 2015

 

 

 

Retail Pharmacy

 

Pharmacy Services

 

Total

 

Balance, February 28, 2015

 

$

76,124

 

$

 

$

76,124

 

Acquisition (see Note 2. Acquisition)

 

 

1,457,703

 

1,457,703

 

Balance, August 29, 2015

 

$

76,124

 

$

1,457,703

 

$

1,533,827

 

 

The Company’s other intangible assets are finite-lived and amortized over their useful lives. Following is a summary of the Company’s finite-lived and indefinitely-lived intangible assets as of August 29, 2015 and February 28, 2015.

 

 

 

August 29, 2015

 

February 28, 2015

 

 

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net

 

Remaining
Weighted
Average
Amortization
Period

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net

 

Remaining
Weighted
Average
Amortization
Period

 

Favorable leases and other

 

$

663,323

 

$

(498,624

)

$

164,699

 

8 years

 

$

653,377

 

$

(481,041

)

$

172,336

 

8 years

 

Prescription files

 

1,470,997

 

(1,235,710

)

235,287

 

3 years

 

1,440,154

 

(1,191,010

)

249,144

 

3 years

 

Customer relationships(a)

 

585,500

 

(12,769

)

572,731

 

17 years

 

 

 

 

 

 

CMS license

 

108,000

 

(792

)

107,208

 

25 years

 

 

 

 

 

 

Claims adjudication and other developed software

 

59,500

 

(1,558

)

57,942

 

7 years

 

 

 

 

 

 

Trademarks

 

15,600

 

(286

)

15,314

 

10 years

 

 

 

 

 

 

Backlog

 

12,500

 

(764

)

11,736

 

3 years

 

 

 

 

 

 

Other

 

17,485

 

(871

)

16,614

 

5 years

 

 

 

 

 

 

Total finite

 

$

2,932,905

 

$

(1,751,374

)

1,181,531

 

 

 

$

2,093,531

 

$

(1,672,051

)

$

421,480

 

 

 

Trademarks

 

44,000

 

 

44,000

 

Indefinite

 

 

 

 

 

 

Total

 

$

2,976,905

 

$

(1,751,374

)

$

1,225,531

 

 

 

$

2,093,531

 

$

(1,672,051

)

$

421,480

 

 

 

 


(a)              — Amortized on an accelerated basis which is determined based on the remaining useful economic lives of the customer relationships that are expected to contribute directly or indirectly to future cash flows.

 

Also included in other non-current liabilities as of August 29, 2015 and February 28, 2015 are unfavorable lease intangibles with a net carrying amount of $51,382 and $55,571, respectively. These intangible liabilities are amortized over their remaining lease terms at the time of acquisition.

 

Amortization expense for these intangible assets and liabilities was $48,609 and $80,550 for the thirteen and twenty-six week periods ended August 29, 2015, respectively. Amortization expense for these intangible assets and liabilities was $28,532 and $57,769 for the thirteen and twenty-six week periods ended August 30, 2014, respectively. The anticipated annual amortization expense for these intangible assets and liabilities is 2016—$186,283; 2017—$206,363; 2018—$166,250; 2019—$130,231 and 2020—$100,716.

 

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Table of Contents

 

RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

9. Indebtedness and Credit Agreements

 

Following is a summary of indebtedness and lease financing obligations at August 29, 2015 and February 28, 2015:

 

 

 

August 29,
2015

 

February 28,
2015

 

Secured Debt:

 

 

 

 

 

Senior secured revolving credit facility due January 2020

 

$

2,453,000

 

$

1,725,000

 

8.00% senior secured notes (senior lien) due August 2020

 

 

650,000

 

Tranche 1 Term Loan (second lien) due August 2020

 

470,000

 

470,000

 

Tranche 2 Term Loan (second lien) due June 2021

 

500,000

 

500,000

 

Other secured

 

91

 

5,367

 

 

 

3,423,091

 

3,350,367

 

Unsecured Guaranteed Debt:

 

 

 

 

 

9.25% senior notes due March 2020 ($902,000 face value plus unamortized premium of $3,079 and $3,415)

 

905,079

 

905,415

 

6.75% senior notes due June 2021

 

810,000

 

810,000

 

6.125% senior notes due April 2023

 

1,800,000

 

 

 

 

3,515,079

 

1,715,415

 

Unsecured Unguaranteed Debt:

 

 

 

 

 

8.5% convertible notes due May 2015

 

 

64,168

 

7.7% notes due February 2027

 

295,000

 

295,000

 

6.875% fixed-rate senior notes due December 2028

 

128,000

 

128,000

 

 

 

423,000

 

487,168

 

Lease financing obligations

 

83,143

 

91,993

 

Total debt

 

7,444,313

 

5,644,943

 

Current maturities of long-term debt and lease financing obligations

 

(29,002

)

(100,376

)

Long-term debt and lease financing obligations, less current maturities

 

$

7,415,311

 

$

5,544,567

 

 

Credit Facility

 

On January 13, 2015, the Company amended and restated its senior secured credit facility (“Amended and Restated Senior Secured Credit Facility” or “revolver”), which, among other things, increased borrowing capacity from $1,795,000 to $3,000,000 (which further increased to $3,700,000 upon the redemption of its 8.00% senior secured notes due August 2020 (“8.00% Notes”) on August 15, 2015), and extended the maturity to January 2020 from February 2018. The Company used borrowings under the revolver to repay and retire all of the $1,143,650 outstanding under its Tranche 7 Senior Secured Term Loan due 2020, along with associated fees and expenses. Borrowings under the revolver bear interest at a rate per annum between LIBOR plus 1.50% and LIBOR plus 2.00% based upon the average revolver availability (as defined in the Amended and Restated Senior Secured Credit Facility). The Company is 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.

 

On February 10, 2015, the Company amended the Amended and Restated Senior Secured Credit Facility to, among other things, increase the flexibility of Rite Aid to incur and/or issue unsecured indebtedness, including in connection with the Acquisition, and made certain other modifications to the covenants applicable to Rite Aid and its subsidiaries.

 

The Company’s ability to borrow under the revolver is based upon a specified borrowing base consisting of accounts receivable, inventory and prescription files. At August 29, 2015, the Company had $2,453,000 of borrowings outstanding under the revolver and had letters of credit outstanding against the revolver of $70,916, which resulted in additional borrowing capacity of $1,176,084.

 

The Amended and Restated Senior Secured Credit Facility restricts the Company and the Subsidiary Guarantors (as defined herein) from accumulating cash on hand, and under certain circumstances, requires the funds in the Company’s deposit accounts to be applied first to the repayment of outstanding revolving loans under the Amended and Restated Senior Secured Credit Facility and then to be held as collateral for the senior obligations. This provision did not apply to the proceeds from the 6.125% Notes as discussed in the “Financing for the Acquisition” section below.

 

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Table of Contents

 

RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

The Amended and Restated Senior Secured Credit Facility allows the Company to have outstanding, at any time, up to $1,500,000 (or $1,800,000 solely to the extent incurred for the purpose of funding of the Acquisition) 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 $750,000 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 the Company 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 the Company’s 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 the Company is 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 the Company maintains availability under its revolving credit facility of more than $365,000.

 

As of January 13, 2015, the Amended and Restated Senior Secured Credit Facility has a financial covenant that requires the Company to maintain a minimum fixed charge coverage ratio of 1.00 to 1.00 (a) on any date on which availability under the revolving credit facility is less than $200,000 or (b) on the third consecutive business day on which availability under the revolving credit facility is less than $250,000 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 revolving credit facility is equal to or greater than $250,000. As of August 29, 2015, the availability was at a level that did not trigger this 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 also provides for customary events of default.

 

The Company also has two second priority secured term loan facilities. The first includes a $470,000 second priority secured term loan (the “Tranche 1 Term Loan”). The Tranche 1 Term Loan matures on August 21, 2020 and currently bears interest at a rate per annum equal to LIBOR plus 4.75% with a LIBOR floor of 1.00%, if the Company chooses to make LIBOR borrowings, or at Citibank’s base rate plus 3.75%. The second includes a $500,000 second priority secured term loan (the “Tranche 2 Term Loan”). 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 the Company chooses to make LIBOR borrowings, or at Citibank’s base rate plus 2.875%.

 

With the exception of EIC, substantially all of Rite Aid Corporation’s 100 percent owned subsidiaries guarantee the obligations under the Amended and Restated Senior Secured Credit Facility, second priority secured term loan facilities, and unsecured guaranteed notes. The Amended and Restated Senior Secured Credit Facility and second priority secured term loan facilities are secured, on a senior or second priority basis, as applicable, by a lien on, among other things, accounts receivable, inventory and prescription files of the Subsidiary Guarantors. The subsidiary guarantees related to the Company’s Amended and Restated Senior Secured Credit Facility and second priority secured term loan facilities and, on an unsecured basis, the unsecured guaranteed notes are full and unconditional and joint and several, and there are no restrictions on the ability of the Company to obtain funds from its subsidiaries. The Company has no independent assets or operations. Additionally, prior to the Acquisition, the subsidiaries, including joint ventures, that did not guarantee the Amended and Restated Senior Secured Credit Facility, the credit facility, second priority secured term loan facilities and applicable notes, were minor. Accordingly, condensed consolidating financial information for the Company and subsidiaries is not presented for those periods. Subsequent to the Acquisition, other than EIC, the subsidiaries, including joint ventures, that do not guarantee the credit facility, second priority secured term loan facilities and applicable notes, are minor.  As such, condensed consolidating financial information for the Company, its guaranteeing subsidiaries and non-guaranteeing subsidiary, EIC, is presented for those periods subsequent to the Acquisition. See Note 15 “Guarantor and Non-Guarantor Condensed Consolidating Financial Information” for additional disclosure.

 

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Table of Contents

 

RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

Financing for the Acquisition

 

On April 2, 2015, the Company issued $1,800,000 aggregate principal amount of its 6.125% Notes, the net proceeds of which, along with other available cash and borrowings under its Amended and Restated Senior Secured Credit Facility, were used to finance the cash portion of the Acquisition, which closed on June 24, 2015. The Company’s obligations under the notes are fully and unconditionally guaranteed, jointly and severally, on an unsubordinated basis, by all of its subsidiaries that guarantee the Company’s obligations under the Amended and Restated Senior Secured Credit Facility, second priority secured term loan facilities, 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, among others, 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 its other unsecured, unsubordinated indebtedness.

 

Other Transactions

 

During May 2015, $64,089 of the Company’s 8.5% convertible notes due 2015 were converted into 24,762 shares of common stock, pursuant to their terms. The remaining $79 of the Company’s 8.5% convertible notes due 2015 were repurchased by the Company upon maturity.

 

On August 15, 2015, the Company completed the redemption of all of its outstanding $650,000 aggregate principal amount of its 8.00% Notes. In connection with the redemption, the Company recorded a loss on debt retirement, including call premium and unamortized debt issue costs, of $33,205 during the second quarter of fiscal 2016.

 

Maturities

 

The aggregate annual principal payments of long-term debt for the remainder of fiscal 2016 and thereafter are as follows: 2016—$90; 2017—$0; 2018—$0; 2019—$0; 2020—$2,453,000 and $4,905,001 thereafter.

 

10. Stock Options and Stock Awards

 

The Company recognizes share-based compensation expense over the requisite service period of the award, net of an estimate for the impact of forfeitures. Operating results for the twenty-six week periods ended August 29, 2015 and August 30, 2014 include $16,201 and $9,892, respectively, of compensation costs related to the Company’s stock-based compensation arrangements.

 

Beginning in fiscal 2015, the Company provided certain of its associates with performance based incentive plans under which the associates will receive a certain number of shares of the Company’s common stock based on the Company meeting certain financial and performance goals. During the twenty-six week periods ended August 29, 2015 and August 30, 2014, the Company incurred $4,413 and $444 related to these performance based incentive plans, respectively, which is recorded as a component of stock-based compensation expense.

 

The total number and type of newly awarded grants and the related weighted average fair value for the twenty-six week periods ended August 29, 2015 and August 30, 2014 are as follows:

 

 

 

August 29, 2015

 

August 30, 2014

 

 

 

Shares

 

Weighted
Average
Fair Value

 

Shares

 

Weighted
Average
Fair Value

 

Stock options granted

 

3,647

 

$

4.45

 

3,113

 

$

4.43

 

Restricted stock awards granted

 

2,177

 

$

8.68

 

3,304

 

$

7.01

 

Total awards

 

5,824

 

 

 

6,417

 

 

 

 

Typically, stock options granted vest, and are subsequently exercisable in equal annual installments over a four-year period for employees. Restricted stock awards typically vest in equal annual installments over a three-year period.

 

The Company calculates the fair value of stock options using the Black- Scholes-Merton option pricing model. The following assumptions were used in the Black-Scholes-Merton option pricing model:

 

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Table of Contents

 

RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

 

 

Twenty-Six Week Period
Ended

 

 

 

August 29,
2015

 

August 30,
2014

 

Expected stock price volatility

 

56%

 

74%

 

Expected dividend yield

 

0%

 

0%

 

Risk-free interest rate

 

1.7%

 

1.7%

 

Expected option life

 

5.5 years

 

5.5 years

 

 

As of August 29, 2015, the total unrecognized pre-tax compensation costs related to unvested stock options and restricted stock awards granted, net of estimated forfeitures and the weighted average period of cost amortization are as follows:

 

 

 

August 29, 2015

 

 

 

Unvested
stock
options

 

Unvested
restricted
stock

 

Unvested
performance
shares

 

Unrecognized pre-tax costs

 

$

27,657

 

$

32,336

 

$

33,571

 

Weighted average amortization period

 

3.0 years

 

2.5 years

 

2.2 years

 

 

11. Reclassifications from Accumulated Other Comprehensive Loss

 

The following table summarizes the components of accumulated other comprehensive loss and the changes in balances of each component of accumulated other comprehensive loss, net of tax as applicable, for the thirteen and twenty-six week periods ended August 29, 2015 and August 30, 2014:

 

 

 

Thirteen Week Period
Ended
August 29, 2015

 

Thirteen Week Period
Ended
August 30, 2014

 

Twenty-Six Week Period
Ended August 29, 2015

 

Twenty-Six Week Period
Ended August 30, 2014

 

 

 

Defined
benefit
pension
plans

 

Accumulated
other
comprehensive
loss

 

Defined
benefit
pension
plans

 

Accumulated
other
comprehensive
loss

 

Defined
benefit
pension
plans

 

Accumulated
other
comprehensive
loss

 

Defined
benefit
pension
plans

 

Accumulated
other
comprehensive
loss

 

Accumulated other comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance-beginning of period

 

$

(45,253

)

$

(45,253

)

$

(36,675

)

$

(36,675

)

$

(45,850

)

$

(45,850

)

$

(37,334

)

$

(37,334

)

Amounts reclassified from accumulated other comprehensive loss to net income, net of $398, $0, $796, and $0 tax expense

 

598

 

598

 

660

 

660

 

1,195

 

1,195

 

1,319

 

1,319

 

Balance-end of period

 

$

(44,655

)

$

(44,655

)

$

(36,015

)

$

(36,015

)

$

(44,655

)

$

(44,655

)

$

(36,015

)

$

(36,015

)

 

The following table summarizes the effects on net income of significant amounts classified out of each component of accumulated other comprehensive loss for the thirteen and twenty-six week periods ended August 29, 2015 and August 30, 2014:

 

 

 

Thirteen Week Periods Ended August 29, 2015 and August 30, 2014

 

 

 

Amount
reclassified from
accumulated other
comprehensive loss

 

 

 

Details about accumulated other
comprehensive loss components

 

August 29,
2015

 

August 30,
2014

 

Affected line item in the condensed
consolidated statements of operations

 

Defined benefit pension plans

 

 

 

 

 

 

 

Amortization of unrecognized prior service cost(a)

 

$

(18

)

$

(60

)

Selling, general and administrative expenses

 

Amortization of unrecognized net loss(a)

 

(978

)

(600

)

Selling, general and administrative expenses

 

 

 

(996

)

(660

)

Total before income tax expense

 

 

 

398

 

 

Income tax expense(b)

 

 

 

$

(598

)

$

(660

)

Net of income tax expense

 

 

 

 

Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

 

 

Amount
reclassified from
accumulated other
comprehensive loss

 

 

 

Details about accumulated other
comprehensive loss components

 

August 29,
2015

 

August 30,
2014

 

Affected line item in the condensed
consolidated statements of operations

 

Defined benefit pension plans

 

 

 

 

 

 

 

Amortization of unrecognized prior service cost(a)

 

$

(34

)

$

(120

)

Selling, general and administrative expenses

 

Amortization of unrecognized net loss(a)

 

(1,957

)

(1,199

)

Selling, general and administrative expenses

 

 

 

(1,991

)

(1,319

)

Total before income tax expense

 

 

 

796

 

 

Income tax expense(b)

 

 

 

$

(1,195

)

$

(1,319

)

Net of income tax expense

 

 

24



Table of Contents

 

RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 


(a)                                 See Note 12, Retirement Plans for additional details.

 

(b)                                 Income tax expense is $0 for August 30, 2014 due to the valuation allowance. See Note 6, Income Taxes for additional details.

 

12. Retirement Plans

 

Net periodic pension expense recorded in the thirteen and twenty- six week periods ended August 29, 2015 and August 30, 2014, for the Company’s defined benefit plans includes the following components:

 

 

 

Defined Benefit
Pension Plan

 

Nonqualified
Executive Retirement
Plans

 

Defined Benefit
Pension Plan

 

Nonqualified
Executive Retirement
Plans

 

 

 

Thirteen Week Period Ended

 

Twenty-Six Week Period Ended

 

 

 

August 29,
2015

 

August 30,
2014

 

August 29,
2015

 

August 30,
2014

 

August 29,
2015

 

August 30,
2014

 

August 29,
2015

 

August 30,
2014

 

Service cost

 

$

513

 

$

792

 

$

 

$

 

$

1,025

 

$

1,585

 

$

 

$

 

Interest cost

 

1,634

 

1,631

 

119

 

135

 

3,267

 

3,262

 

237

 

270

 

Expected return on plan assets

 

(1,593

)

(1,929

)

 

 

(3,186

)

(3,858

)

 

 

Amortization of unrecognized prior service cost

 

18

 

60

 

 

 

34

 

120

 

 

 

Amortization of unrecognized net loss

 

978

 

600

 

 

 

1,957

 

1,199

 

 

 

Net pension expense

 

$

1,550

 

$

1,154

 

$

119

 

$

135

 

$

3,097

 

$

2,308

 

$

237

 

$

270

 

 

During the thirteen and twenty-six week periods ended August 29, 2015 the Company contributed $395 and $772, respectively, to the Nonqualified Executive Retirement Plans and $0 to the Defined Benefit Pension Plan. During the remainder of fiscal 2016, the Company expects to contribute $769 to the Nonqualified Executive Retirement Plans and $0 to the Defined Benefit Pension Plan.

 

13. Segment Reporting

 

Prior to June 24, 2015, the Company’s operations were within one reportable segment.  As a result of the completion of the Acquisition, the Company has realigned its internal management reporting to reflect two reportable segments, its retail drug stores (“Retail Pharmacy”), and its pharmacy services (“Pharmacy Services”) segments.

 

The Retail Pharmacy segment’s primary business is the sale of prescription drugs and related consultation to its customers.  Additionally, the Retail Pharmacy segment sells a full selection of health and beauty aids and personal care products, seasonal merchandise and a large private brand product line. The Pharmacy Services segment offers a full range of pharmacy benefit management services including plan design and administration, on both a transparent pass-through model and traditional model, formulary management and claims processing.  Additionally, the Pharmacy Services segment offers specialty and mail order services, infertility treatment, and drug benefits to eligible beneficiaries under the federal government’s Medicare Part D program.

 

The Parent Company’s chief operating decision makers are its Parent Company Chief Executive Officer, Parent Company President and CEO - Retail Pharmacy, CEO - Pharmacy Services, Chief Financial Officer, and its Senior Executive Vice Presidents (collectively the “CODM”).  The CODM has ultimate responsibility for enterprise decisions.  The CODM determines, in particular, resource allocation for, and monitors performance of, the consolidated enterprise, the Retail Pharmacy segment and the Pharmacy Services segment.  The Retail Pharmacy and Pharmacy Services segment managers have responsibility for operating decisions, allocating resources and assessing performance within their respective segments. The CODM relies on internal management reporting that analyzes enterprise results on certain key performance indicators, namely, revenues, gross profit, and Adjusted EBITDA.

 

The following table is a reconciliation of the Company’s business segments to the condensed consolidated financial statements:

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

 

 

Retail
Pharmacy

 

Pharmacy
Services

 

Intersegment
Eliminations (1)

 

Consolidated

 

Thirteen Week Period Ended

 

 

 

 

 

 

 

 

 

August 29, 2015:

 

 

 

 

 

 

 

 

 

Revenues

 

$

6,647,243

 

$

1,071,889

 

$

(54,356

)

$

7,664,776

 

Gross Profit

 

1,860,513

 

61,778

 

 

1,922,291

 

Adjusted EBITDA

 

313,602

 

33,222

 

 

346,824

 

August 30, 2014:

 

 

 

 

 

 

 

 

 

Revenues

 

$

6,522,584

 

$

 

$

 

$

6,522,584

 

Gross Profit

 

1,894,579

 

 

 

1,894,579

 

Adjusted EBITDA

 

364,166

 

 

 

364,166

 

Twenty-Six Week Period Ended

 

 

 

 

 

 

 

 

 

August 29, 2015:

 

 

 

 

 

 

 

 

 

Revenues

 

$

13,294,804

 

$

1,071,889

 

$

(54,356

)

$

14,312,337

 

Gross Profit

 

3,720,043

 

61,778

 

 

3,781,821

 

Adjusted EBITDA

 

612,865

 

33,222

 

 

646,087

 

August 30, 2014:

 

 

 

 

 

 

 

 

 

Revenues

 

$

12,988,115

 

$

 

$

 

$

12,988,115

 

Gross Profit

 

3,697,558

 

 

 

3,697,558

 

Adjusted EBITDA

 

646,779

 

 

 

646,779

 

 


(1)         Intersegment eliminations include intersegment revenues and corresponding cost of revenues that occur when Pharmacy Services segment customers use Retail Pharmacy segment stores to purchase covered products. When this occurs, both the Retail Pharmacy and Pharmacy Services segments record the revenue on a stand-alone basis.

 

The following table reconciles net income to Adjusted EBITDA for the thirteen and twenty-six week periods ended August 29, 2015 and August 30, 2014:

 

 

 

Thirteen Week
Period Ended

 

Twenty-Six Week
Period Ended

 

 

 

August 29,
2015

 

August 30,
2014

 

August 29,
2015

 

August 30,
2014

 

 

 

(dollars in thousands)

 

Net income

 

$

21,469

 

$

127,849

 

$

40,305

 

$

169,295

 

Interest expense

 

115,410

 

100,950

 

239,017

 

201,770

 

Income tax expense

 

16,463

 

19,860

 

28,904

 

31,741

 

Depreciation and amortization expense

 

127,699

 

101,484

 

237,348

 

204,589

 

LIFO charges

 

5,986

 

1,544

 

11,973

 

3,089

 

Lease termination and impairment charges

 

9,637

 

7,111

 

14,659

 

11,959

 

Loss on debt retirements, net

 

33,205

 

 

33,205

 

 

Other

 

16,955

 

5,368

 

40,676

 

24,336

 

Adjusted EBITDA

 

$

346,824

 

$

364,166

 

$

646,087

 

$

646,779

 

 

The following is balance sheet information for the Company’s reportable segments:

 

 

 

Retail
Pharmacy

 

Pharmacy
Services

 

Eliminations (2)

 

Consolidated

 

August 29, 2015:

 

 

 

 

 

 

 

 

 

Total Assets

 

$

8,848,115

 

$

3,310,325

 

$

(179,209

)

$

11,979,231

 

Goodwill

 

76,124

 

1,457,703

 

 

1,533,827

 

Additions to property and equipment and intangible assets

 

314,774

 

371

 

 

315,145

 

February 28, 2015:

 

 

 

 

 

 

 

 

 

Total Assets

 

$

8,863,252

 

$

 

$

 

$

8,863,252

 

Goodwill

 

76,124

 

 

 

76,124

 

Additions to property and equipment and intangible assets

 

539,386

 

 

 

539,386

 

 


(2)         Intersegment eliminations include netting of the Pharmacy Services segment long-term deferred tax liability of $143,000 against the Retail Pharmacy segment long-term deferred tax asset for consolidation purposes in accordance with ASC 740, and intersegment accounts receivable of $36,209, as of August 29, 2015, that represents amounts owed from the

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

Pharmacy Services segment to the Retail Pharmacy segment that are created when Pharmacy Services segment customers use Retail Pharmacy segment stores to purchase covered products.

 

14. Commitments and Contingencies

 

Legal Matters

 

The Company is a party to legal proceedings, investigations and claims in the ordinary course of its business, including the matters described below. The Company records accruals for outstanding legal matters when it believes it is probable that a loss will be incurred and the amount can be reasonably estimated. The Company evaluates, on a quarterly basis, developments in legal matters that could affect the amount of any accrual and developments that would make a loss contingency both probable and reasonably estimable. If a loss contingency is not both probable and estimable, the Company does not establish an accrued liability.

 

The Company’s contingencies are subject to significant uncertainties, including, among other factors: (i) proceedings are in early stages; (ii) whether class or collective action status is sought and the likelihood of a class being certified; (iii) the outcome of pending appeals or motions; (iv) the extent of potential damages, fines or penalties, which are often unspecified or indeterminate; (v) the impact of discovery on the matter; (vi) whether novel or unsettled legal theories are at issue; (vii) there are significant factual issues to be resolved; and/or (viii) in the case of certain government agency investigations, whether a sealed qui tam lawsuit (“whistleblower” action) has been filed and whether the government agency makes a decision to intervene in the lawsuit following investigation.

 

The Company has 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 the Company’s stores at various locations around the country. The lawsuit alleges that the Company 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, punitive 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 Company 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 the Company’s motion for decertification of the nationwide collective action claims. The Company filed a motion seeking reconsideration of the Court’s September 26, 2013 decision which motion was denied in June 2014. The Company 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. At this time, the Company is not able to either predict the outcome of this lawsuit or estimate a potential range of loss with respect to the lawsuit. The Company’s management believes, however, that this lawsuit is without merit and is vigorously defending this lawsuit.

 

The Company is currently a defendant in several putative class action 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, pay for missed meals and rest periods, failure to reimburse business expenses and failure to provide employee seating (the “California Cases”). These suits purport to be class actions and seek substantial damages. The Company has aggressively challenged both the merits of the lawsuits and the allegations that the cases should be certified as class or representative actions.

 

With respect to cases involving pharmacist meal and rest periods (Chase and Scherwin v. Rite Aid Corporation pending in Los Angeles County Superior Court and Kyle v. Rite Aid Corporation pending in Sacramento County Superior Court), during the period ended March 1, 2014, the Company recorded a legal accrual with respect to these matters. The Company and the attorneys representing the putative class of pharmacists have agreed to a class wide settlement of the case of $9.0 million subject to final Court approval. The parties are in the process of obtaining Court approval.

 

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. The Company filed its motion for decertification, which motion was granted in November 2012. Plaintiff subsequently appealed the Court’s order which appeal was granted in May 2014. The Company filed a petition for review of the appellate court’s decision with the California Supreme Court, which petition was denied in August 2014. Proceedings in the Hall case are stayed pending a decision by the California Supreme Court in two similar cases. With respect to the California Cases (other than Chase and Scherwin and Kyle), the Company, at this time, is not able to predict either the outcome of these lawsuits or estimate a potential range of loss with respect to said lawsuits.

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

The Company was 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, the Company was 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.  The Company has 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 have entered into an agreement tolling the statute of limitations until October 7, 2015.  The parties agreed to extend the tolling agreement until April 7, 2016.  At this stage of the proceedings, Rite Aid is unable to predict the outcome of any review by the government of such information.

 

In April 2012, the Company received an administrative subpoena from the Drug Enforcement Administration (“DEA”), Albany, New York District Office, requesting information regarding the Company’s sale of products containing pseudoephedrine (“PSE”). In April 2012, it also received a communication from the United States 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”). In April 2013, the Company received additional administrative subpoenas from DEA concerning certain retail PSE transactions at New York stores and the USAO commenced discussions with the Company regarding whether, from 2009 (upon implementation of an electronic PSE transaction logbook system) through the present, the Company sold products containing PSE in violation of the CMEA. The Company received additional administrative subpoenas from the DEA beginning in December 2013 requesting information in connection with an investigation of violations of the CMEA in West Virginia and New York.  On September 2, 2015, the Company received a grand jury subpoena from the United States District Court for the Southern District of West Virginia seeking additional information in connection with the investigation of violations of the CMEA in West Virginia.  Violations of the CMEA could result in the imposition of administrative, civil and/or criminal penalties against the Company. The Company is cooperating with the government and continues to provide information responsive to the subpoenas. The Company has entered into a tolling agreement with the USAO. Discussions are underway to resolve these matters with the United States Attorney’s Offices for the Northern District of New York, the Eastern District of New York, and the Southern District of West Virginia, but whether an agreement can be reached and on what terms are uncertain. While the Company’s management cannot predict the outcome of these matters, it is possible that the Company’s results of operations or cash flows could be materially affected by an unfavorable resolution.

 

In January 2013, the DEA, Los Angeles District Office, served an administrative subpoena on the Company seeking documents related to prescriptions by a certain prescriber. The USAO, Central District of California, also contacted the Company about a related investigation into allegations that Rite Aid pharmacies filled certain controlled substance prescriptions for a number of practitioners after their DEA registrations had expired or otherwise become invalid in violation of the federal Controlled Substances Act and DEA regulations. The Company responded to the administrative subpoena and subsequent informal requests for information from the USAO. The Company met with the USAO and DEA in January 2014 and is involved in ongoing discussions with the government regarding this matter. The Company recorded a legal accrual during the period ended March 1, 2014.

 

The Company was served with a Civil Investigative Demand (“CID”) dated June 21, 2013 by the USAO for the Eastern District of California and the Attorney General’s Office of the State of California (the “AG”). The CID requests records and responses to interrogatories regarding Rite Aid’s Drug Utilization Review and prescription dispensing protocol and the dispensing of drugs designated “Code 1” by the State of California. The Company is in the process of producing responsive documents and interrogatory responses to the USAO and AG and is unable to predict the timing or outcome of any review by the government of such information.

 

In addition to the above described matters, the Company is subject from time to time to various claims and lawsuits and governmental investigations arising in the ordinary course of business. While the Company’s management cannot predict the outcome of any of the claims, the Company’s management does not believe that the outcome of any of these legal matters will be material to the Company’s consolidated financial position. It is possible, however, that the Company’s results of operations or cash flows could be materially affected by an unfavorable resolution of pending litigation or contingencies.

 

Contingencies

 

The California Department of Health Care Services (“DHCS”), the agency responsible for administering the State of California Medicaid program, implemented retroactive reimbursement rate reductions effective June 1, 2011, impacting the medical provider community in California, including pharmacies. Numerous medical providers, including representatives of both chain and independent pharmacies, filed suits against DHCS in Federal District Court in California and obtained preliminary injunctions against the rate cuts, subject to a trial on the merits. DHCS appealed the preliminary injunctions to the Ninth Circuit Court of Appeals, which Court vacated the injunctions. Based upon the actions of DHCS and the decision of the Appeals Court, the Company recorded an appropriate accrual. In January 2014, the Center for Medicare and Medicaid Services approved a state plan amendment that excluded certain drugs from the retroactive reimbursement rate reductions effective March 31, 2012. Accordingly, the Company adjusted its

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

For the Thirteen and Twenty-Six Week Periods Ended August 29, 2015 and August 30, 2014

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

accrual during that fiscal year to take into account this exclusion. As pertinent facts and circumstances develop, this accrual may be adjusted further.

 

15. Guarantor and Non-Guarantor Condensed Consolidating Financial Information

 

Rite Aid Corporation conducts the majority of its business through its subsidiaries.  With the exception of EIC, substantially all of Rite Aid Corporation’s 100 percent owned subsidiaries guarantee the 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”). Additionally, prior to the Acquisition, the subsidiaries, including joint ventures, that did not guarantee the Amended and Restated Senior Secured Credit Facility, second priority secured term loan facilities, secured guaranteed notes and unsecured guaranteed notes, were minor. Accordingly, condensed consolidating financial information for the Company and subsidiaries is not presented for those periods. Condensed consolidating financial information for the Company, its Subsidiary Guarantors and non-guarantor subsidiaries, is presented for periods subsequent to the Acquisition.

 

For the purposes of preparing the information below, Rite Aid Corporation uses the equity method to account for its investment in subsidiaries. The equity method has been used by Subsidiary Guarantors with respect to investments in the non-guarantor subsidiaries. The subsidiary guarantees related to the Company’s Amended and Restated Senior Secured Credit Facility, second priority secured term loan facilities and secured guaranteed notes and, on an unsecured basis, the unsecured guaranteed notes, are full and unconditional and joint and several.  Presented below is condensed consolidating financial information for Rite Aid Corporation, the Subsidiary Guarantors, and the Non-Guarantor Subsidiaries at August 29, 2015 and for the thirteen and twenty-six week periods ended August 29, 2015.  Separate financial statements for Subsidiary Guarantors are not presented.

 

 

 

Rite Aid Corporation

 

 

 

Condensed Consolidating Balance Sheet

 

 

 

August 29, 2015

 

 

 

(unaudited)

 

 

 

Rite Aid
Corporation (Parent
Company Only)

 

Subsidiary
Guarantors

 

Non-
Guarantor
Subsidiaries

 

Eliminations

 

Consolidated

 

 

 

(in thousands)

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

 

$

120,905

 

$

31,742

 

$

 

$

152,647

 

Accounts receivable, net

 

 

1,299,313

 

573,663

 

 

1,872,976

 

Intercompany receivable

 

 

 

271,673

 

 

(271,673

)(a)

 

Inventories, net of LIFO reserve of $0, $1,009,501, $0, $0, and $1,009,501

 

 

2,902,749

 

 

 

2,902,749

 

Deferred tax assets

 

 

17,122

 

701

 

 

17,823

 

Prepaid expenses and other current assets

 

 

137,841

 

3,098

 

 

140,939

 

Total current assets

 

 

4,749,603

 

609,204

 

(271,673

)

5,087,134

 

Property, plant and equipment, net

 

 

2,198,674

 

 

 

2,198,674

 

Goodwill

 

 

1,533,827

 

 

 

1,533,827

 

Other intangibles, net

 

 

1,117,595

 

107,936

 

 

1,225,531

 

Deferred tax assets

 

 

1,617,311

 

 

 

1,617,311

 

Investment in subsidiaries

 

14,527,800

 

129,383