RITE AID CORP - Quarter Report: 2016 November (Form 10-Q)

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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 November 26, 2016

 

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)

 

 

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.

 

 

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 1,052,367,228 shares of its $1.00 par value common stock outstanding as of December 21, 2016.

 

 

 

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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 November 26, 2016 and February 27, 2016	4
	Condensed Consolidated Statements of Operations for the Thirteen Week Periods Ended November 26, 2016 and November 28, 2015	5
	Condensed Consolidated Statements of Comprehensive Income for the Thirteen Week Periods Ended November 26, 2016 and November 28, 2015	6
	Condensed Consolidated Statements of Operations for the Thirty-Nine Week Periods Ended November 26, 2016 and November 28, 2015	7
	Condensed Consolidated Statements of Comprehensive Income for the Thirty-Nine Week Periods Ended November 26, 2016 and November 28, 2015	8
	Condensed Consolidated Statements of Cash Flows for the Thirty-Nine Week Periods Ended November 26, 2016 and November 28, 2015	9
	Notes to Condensed Consolidated Financial Statements	10
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	33
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	46
ITEM 4.	Controls and Procedures	48
PART II OTHER INFORMATION
ITEM 1.	Legal Proceedings	49
ITEM 1A.	Risk Factors	49
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	51
ITEM 3.	Defaults Upon Senior Securities	51
ITEM 4.	Mine Safety Disclosures	51
ITEM 5.	Other Information	51
ITEM 6.	Exhibits	52

 

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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;

 

·                  the continued impact of private and public third party payors reduction in prescription drug reimbursement rates and their ongoing 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, and our ability to achieve drug pricing efficiencies;

 

·                  the inability to complete the proposed acquisition (the “Merger”) of us by Walgreens Boots Alliance, Inc., a Delaware corporation (“WBA”), due to the failure to satisfy the remaining conditions to the completion of the Merger, including receipt of required regulatory approvals;

 

·                  the inability to complete the proposed Sale (as defined below) to a wholly owned subsidiary of Fred’s, Inc. (“Fred’s”) due to the failure to satisfy the conditions to the completion of the Sale, including receipt of required regulatory approvals;

 

·                  the continuing effect of the pending Merger or Sale on our business relationships (including, without limitation, customers and suppliers), operating results and business generally;

 

·                  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 (subject to the limitations in the Merger Agreement), which could result in 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;

 

·                  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 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;

 

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·                  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;

 

·                  the expiration or termination of our Medicare or Medicaid managed care contracts by federal or state governments and related tax matters;

 

·                  the risk that the Merger Agreement may be terminated in certain limited circumstances that require us to pay WBA a termination fee of $325 million;

 

·                  risks that the proposed Merger disrupts our current plans and operations or affects our ability to retain or recruit key employees;

 

·                  the amount of the costs, fees, expenses and charges related to the Merger Agreement, the Merger, the Asset Purchase Agreement (as defined below) or the Sale;

 

·                  risks related to the Merger or Sale diverting management’s or employees’ attention from ongoing business operations;

 

·                  risks associated with the financing of the Merger transaction;

 

·                  the risk that our stock price may decline significantly if the Merger is not completed;

 

·                  risks related to obtaining the requisite consents to the Merger or Sale, including, without limitation, the timing (including possible delays) and expiration or termination of the applicable waiting periods under the HSR Act and other applicable antitrust laws, and the risk that such consents might not be received;

 

·                  the risk that the Merger or Sale may not be completed in a timely manner, if at all;

 

·                  risks related to other business effects, including the effects of industry, market, economic, political (including as a result of the recent U.S. Presidential election) or regulatory conditions, future exchange or interest rates or credit ratings, changes in tax laws, regulations, rates and policies or competitive development;

 

·                  the risk that we could experience deterioration in our current Star rating with the Centers of Medicare and Medicaid Services (“CMS”) or incur CMS penalties and/or sanctions;

 

·                  the nature, cost and outcome of pending and future litigation and other legal proceedings or governmental investigations, including any such proceedings related to the Merger or Sale and instituted against us and others;

 

·                  the risk that there may be a material adverse change of the Company or the acquired stores;

 

·                  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 section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein and in our Annual Report on Form 10-K for the fiscal year ended February 27, 2016 (the “Fiscal 2016 10-K “), our Quarterly Report on Form 10-Q for the thirteen weeks ended May 28, 2016 (the “First Quarter 2017 10-Q”) which we filed on July 5, 2016, and our Quarterly Report on Form 10-Q for the thirteen weeks ended August 27, 2016 (the “Second Quarter 2017 10-Q”) which we filed on October 4, 2016, as well as in the “Risk Factors” section of the Fiscal 2016 10-K, which we filed with the SEC on April 25, 2016. 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)

 

		November 26, 2016			February 27, 2016
ASSETS
Current assets:
Cash and cash equivalents		$	220,028		$	124,471
Accounts receivable, net		1,707,648			1,601,008
Inventories, net of LIFO reserve of $1,047,657 and $1,006,396		2,947,358			2,697,104
Prepaid expenses and other current assets		142,134			128,144
Total current assets		5,017,168			4,550,727
Property, plant and equipment, net		2,291,459			2,255,398
Goodwill		1,715,479			1,713,475
Other intangibles, net		885,220			1,004,379
Deferred tax assets		1,534,437			1,539,141
Other assets		215,163			213,890
Total assets		$	11,658,926		$	11,277,010
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt and lease financing obligations		$	22,681		$	26,848
Accounts payable		1,792,574			1,542,797
Accrued salaries, wages and other current liabilities		1,256,283			1,427,250
Total current liabilities		3,071,538			2,996,895
Long-term debt, less current maturities		7,208,286			6,914,393
Lease financing obligations, less current maturities		43,943			52,895
Other noncurrent liabilities		689,032			731,399
Total liabilities		11,012,799			10,695,582
Commitments and contingencies		—			—
Stockholders’ equity:
Common stock, par value $1 per share; 1,500,000 shares authorized; shares issued and outstanding 1,052,268 and 1,047,754		1,052,268			1,047,754
Additional paid-in capital		4,855,612			4,822,665
Accumulated deficit		(5,216,015		)	(5,241,210		)
Accumulated other comprehensive loss		(45,738		)	(47,781		)
Total stockholders’ equity		646,127			581,428
Total liabilities and stockholders’ equity		$	11,658,926		$	11,277,010

 

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
		November 26, 2016			November 28, 2015
Revenues		$	8,089,726		$	8,154,184
Costs and expenses:
Cost of revenues		6,194,866			6,151,305
Selling, general and administrative expenses		1,773,862			1,777,647
Lease termination and impairment charges		7,265			7,011
Interest expense		106,309			106,879
Loss on sale of assets, net		501			3,331
		8,082,803			8,046,173
Income before income taxes		6,923			108,011
Income tax (benefit) expense		(8,087		)	48,468
Net income		$	15,010		$	59,543
Computation of income attributable to common stockholders:
Income attributable to common stockholders—basic and diluted		$	15,010		$	59,543
Basic and diluted income per share		$	0.01		$	0.06

 

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
		November 26, 2016			November 28, 2015
Net income		$	15,010		$	59,543
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 $451 and $398 tax expense		681			597
Total other comprehensive income		681			597
Comprehensive income		$	15,691		$	60,140

 

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)

 

		Thirty-Nine Week Period Ended
		November 26, 2016			November 28, 2015
Revenues		$	24,303,712		$	22,466,521
Costs and expenses:
Cost of revenues		18,597,809			16,681,822
Selling, general and administrative expenses		5,345,356			5,203,058
Lease termination and impairment charges		20,279			21,670
Interest expense		316,810			345,895
Loss on debt retirements, net		—			33,205
Loss on sale of assets, net		1,731			3,651
		24,281,985			22,289,301
Income before income taxes		21,727			177,220
Income tax (benefit) expense		(3,468		)	77,372
Net income		$	25,195		$	99,848
Computation of income attributable to common stockholders:
Income attributable to common stockholders—basic and diluted		$	25,195		$	99,848
Basic and diluted income per share		$	0.02		$	0.10

 

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)

 

		Thirty-Nine Week Period Ended
		November 26, 2016			November 28, 2015
Net income		$	25,195		$	99,848
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 $1,353 and $1,194 tax expense		2,043			1,792
Total other comprehensive income		2,043			1,792
Comprehensive income		$	27,238		$	101,640

 

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)

 

		Thirty-Nine Week Period Ended
		November 26, 2016			November 28, 2015
Operating activities:
Net income		$	25,195		$	99,848
Adjustments to reconcile to net cash provided by operating activities:
Depreciation and amortization		424,084			373,782
Lease termination and impairment charges		20,279			21,670
LIFO charge		41,261			17,959
Loss on sale of assets, net		1,731			3,651
Stock-based compensation expense		36,766			26,529
Loss on debt retirements, net		—			33,205
Changes in deferred taxes		6,165			50,696
Excess tax benefit on stock options and restricted stock		(3,809		)	(21,436		)
Changes in operating assets and liabilities:
Accounts receivable		(110,868		)	315,898
Inventories		(291,574		)	339
Accounts payable		225,278			89,630
Other assets and liabilities, net		(209,055		)	(342,234		)
Net cash provided by operating activities		165,453			669,537
Investing activities:
Payments for property, plant and equipment		(333,788		)	(414,338		)
Intangible assets acquired		(48,805		)	(97,612		)
Acquisition of businesses, net of cash acquired		—			(1,778,377		)
Proceeds from dispositions of assets and investments		10,217			8,697
Net cash used in investing activities		(372,376		)	(2,281,630		)
Financing activities:
Proceeds from issuance of long-term debt		—			1,800,000
Net proceeds from revolver		280,000			655,000
Principal payments on long-term debt		(16,426		)	(666,967		)
Change in zero balance cash accounts		30,685			(35,011		)
Net proceeds from issuance of common stock		4,412			8,625
Financing fees paid for early debt redemption		—			(26,003		)
Excess tax benefit on stock options and restricted stock		3,809			21,436
Deferred financing costs paid		—			(34,634		)
Net cash provided by financing activities		302,480			1,722,446
Increase in cash and cash equivalents		95,557			110,353
Cash and cash equivalents, beginning of period		124,471			115,899
Cash and cash equivalents, end of period		$	220,028		$	226,252
Supplementary cash flow data:
Cash paid for interest (net of capitalized amounts of $147 and $128, respectively)		$	273,713		$	239,869
Cash payments of income taxes, net of refunds		$	6,506		$	5,808
Equipment financed under capital leases		$	3,881		$	3,499
Equipment received for noncash consideration		$	746		$	2,011
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		$	2,774,000		$	3,983,000
Gross payments to revolver		$	2,494,000		$	3,328,000

 

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 Thirty-Nine Week Periods Ended November 26, 2016 and November 28, 2015

 

(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 thirty-nine week periods ended November 26, 2016 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 (“Rite Aid”) and Subsidiaries (together with Rite Aid, the “Company”) Fiscal 2016 10-K.

 

Recent Accounting Pronouncements

 

In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606), an update to ASU 2014-09. This ASU amends ASU 2014-09 to defer the effective date by one year for annual reporting periods beginning after December 15, 2017 (fiscal 2019). Subsequently, the FASB has also issued accounting standards updates which clarify the guidance. This ASU removes inconsistencies, complexities and allows transparency and comparability of revenue transactions across entities, industries, jurisdictions and capital markets by providing a single comprehensive principles-based model with additional disclosures regarding uncertainties. The principles-based revenue recognition model has a five-step analysis of transactions to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Early adoption is permitted for annual reporting periods beginning after December 15, 2016 (fiscal 2018). In transition, the ASU may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption. The Company is in the process of assessing the impact and method of the adoption of the standards on its financial position, results of operations and cash flow.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases, (Topic 842), which is intended to improve financial reporting around leasing transactions. The ASU affects all companies and other organizations that engage in lease transactions (both lessee and lessor) that lease assets such as real estate and manufacturing equipment. This ASU will require organizations that lease assets—referred to as “leases”—to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. ASU No. 2016-02 is effective for fiscal years and interim periods within those years beginning January 1, 2019. The Company is in process of assessing the impact of the adoption of ASU No. 2016-02 on its financial position, results of operations and cash flows.

 

In March 2016, the FASB issued ASU No. 2016-09, Compensation — Stock Compensation, (Topic 718): Improvements to Employee Share-Based Payment Accounting, which is intended to simplify aspects of the accounting for share-based payment transactions. The ASU simplifies the accounting of stock compensation, including income tax implications, the balance sheet classification of awards as either equity or liabilities, and the cash flow classification of employee share based payment transactions. ASU No. 2016-09 is effective for fiscal years and interim periods within those years beginning after December 15, 2016. Early adoption of all the amendments for ASU 2016-09 is permitted. Amendments requiring recognition of excess tax benefits and tax deficiencies in the income statement must be applied prospectively. Amendments related to the presentation of excess tax benefits on the statement of cash flows may be applied either prospectively or retrospectively based on the Company’s election. Amendments related to the statement of cash flows presentation of employee taxes paid when an employer withholds shares must be applied retrospectively. The Company is in process of assessing the impact of the adoption of ASU No. 2016-09 on its financial position, results of operations and cash flows.

 

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2. Acquisition

 

On June 24, 2015, the Company completed its 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 (the “Acquisition”). 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”) service options through its EnvisionRx and MedTrak PBMs, respectively. EnvisionRx also offers fully integrated mail-order and specialty pharmacy services through EnvisionPharmacies; access to the nation’s largest cash pay infertility discount drug program via Design Rx; an innovative claims adjudication software platform in Laker Software; and a national Medicare Part D prescription drug plan through Envision Insurance Company’s (“EIC”) 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 a 100 percent owned subsidiary of the Company.

 

Pursuant to the terms of the Agreement, as consideration for the Acquisition, the Company paid $1,882,211 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 Amended and Restated 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 Company’s condensed consolidated financial statements for the thirteen and thirty-nine week periods ended November 26, 2016 include EnvisionRx results of operations. The Company’s condensed consolidated financial statements for the thirteen and thirty-nine week periods ended November 28, 2015 include EnvisionRx results of operations from the Acquisition date of June 24, 2015 through November 28, 2015 (please see Note 14 Segment Reporting for the Pharmacy Services segment results included within the condensed consolidated financial statements for the thirteen and thirty-nine week periods ended November 26, 2016 and November 28, 2015, which reflects the results of EnvisionRx). The Company’s condensed consolidated financial statements reflect the final purchase accounting adjustments in accordance with ASC 805 “Business Combinations”, whereby the purchase price was 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 is final:

 

Final purchase price
Cash consideration		$	1,882,211
Stock consideration		240,907
Total		$	2,123,118
Final purchase price allocation
Cash and cash equivalents		$	103,834
Accounts receivable		892,678
Inventories		7,276
Prepaid expenses and other current assets		13,386
Total current assets		1,017,174
Property and equipment		13,196
Intangible assets(1)		646,600
Goodwill		1,639,355
Other assets		7,219
Total assets acquired		3,323,544
Accounts payable		491,672
Reinsurance funds held		381,225
Other current liabilities(2)		215,770
Total current liabilities		1,088,667
Other long term liabilities(3)		111,759
Total liabilities assumed		1,200,426
Net assets acquired		$	2,123,118

 

(1)                                 Intangible assets are recorded at estimated fair value, as determined by management based on available information which includes a final 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 earnings methods. The major assumptions used in arriving at the estimated identifiable intangible asset values included

 

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management’s 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 final purchase price allocation include:

 

		Estimated Fair Value			Estimated Useful Life (In Years)
Customer relationships		$	465,000		17
CMS license		57,500			25
Claims adjudication and other developed software		59,000			7
Trademarks		20,100			10
Backlog		11,500			3
Trademarks		33,500			Indefinite
Total		$	646,600

 

(2)                                 Other current liabilities includes $116,057 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. This liability was satisfied with a payment to TPG on November 5, 2015.

 

(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 of $1,639,355 has been allocated to the Pharmacy Services segment of which $1,368,657 is deductible for tax purposes.

 

During the thirteen and thirty-nine week periods ended November 26, 2016, $0 and $6, respectively, of costs related to the Acquisition were expensed by the Company as incurred. During the thirteen and thirty-nine week periods ended November 28, 2015, acquisition costs of $0 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 condensed combined financial data for all periods presented were adjusted to give effect to pro forma 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 to finance the cash portion of the Acquisition.

 

·                  Incremental amortization resulting from increased fair value of the identifiable intangible assets as noted in the final 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.

 

·                  Removal of interest expense incurred by EnvisionRx as the underlying debt was repaid upon the acquisition date.

 

·                  Removal of 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 pro forma combined information is not necessarily 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 combined information does not purport to project the future results of the combined company.

 

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		Thirteen week Periods Ended						Thirty-Nine week Periods Ended
		November 26, 2016			November 28, 2015			November 26, 2016			November 28, 2015
		Pro forma			Pro forma			Pro forma			Pro forma
Net revenues as reported		$	8,089,726		$	8,154,184		$	24,303,712		$	22,466,521
EnvisionRx revenue, prior to the acquisition		—			—			—			1,735,635
Less pre-acquisition intercompany revenue		—			—			—			(104,731		)
Pro forma combined revenues		$	8,089,726		$	8,154,184		$	24,303,712		$	24,097,425
Net income as reported		$	15,010		$	59,543		$	25,195		$	99,848
EnvisionRx net loss before income taxes, prior to the acquisition		—			—			—			(45,307		)
Incremental interest expense on the 6.125% Notes issued on April 2, 2015		—			—			—			(11,097		)
Incremental amortization resulting from fair value adjustments of the identifiable intangible assets		—			—			—			(16,509		)
Transaction costs incurred by both the Company and EnvisionRx		—			—			—			55,864
Interest expense incurred by EnvisionRx		—			—			—			21,984
Debt extinguishment charges incurred by EnvisionRx		—			—			—			31,601
Income tax expense relating to pro forma adjustments		—			—			—			(15,601		)
Pro forma net income		$	15,010		$	59,543		$	25,195		$	120,783
Pro forma basic and diluted income per share		$	0.01		$	0.06		$	0.02		$	0.12

 

The unaudited pro forma condensed combined financial information for the thirteen week periods ended November 26, 2016 and November 28, 2015 is identical to the actual results reported by the Company because EnvisionRx results were included in the consolidated operations of the Company for the entire period. The unaudited pro forma condensed combined financial information for the thirty-nine week period ended November 26, 2016 is identical to the actual results reported by the Company because EnvisionRx results were included in the consolidated operations of the Company for the entire period.

 

3. Pending Merger

 

On October 27, 2015, Rite Aid entered into an Agreement and Plan of Merger (the “Merger Agreement”) with WBA, and Victoria Merger Sub, Inc., a Delaware corporation and a wholly owned direct subsidiary of WBA (“Victoria Merger Sub”). Pursuant to the terms and subject to the conditions set forth in the Merger Agreement, Victoria Merger Sub will merge with and into Rite Aid (the “Merger”), with Rite Aid surviving the Merger as a 100 percent owned direct subsidiary of WBA. On February 4, 2016, the proposal to adopt the Merger Agreement was approved by approximately 97% of the votes cast at the special meeting, which represented approximately 72% of the Company’s total outstanding shares of common stock entitled to vote as of the record date of the special meeting. A quorum of 74% of the Company’s total outstanding shares of common stock as of the record date voted at the special meeting. Completion of the Merger is subject to various closing conditions, including but not limited to (i) the expiration or earlier termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, (ii) the absence of any law or order prohibiting the Merger, and (iii) the absence of a material adverse effect on Rite Aid, as defined in the Merger Agreement. Under the terms of the Merger Agreement, at the effective time of the Merger, each share of Rite Aid’s common stock, par value $1.00 per share, issued and outstanding immediately prior to the effective time (other than shares owned by (i) WBA, Victoria Merger Sub or Rite Aid (which will be cancelled), (ii) stockholders who have properly exercised and perfected appraisal rights under Delaware law, or (iii) any direct or indirect 100 percent owned subsidiary of Rite Aid or WBA (which will be converted into shares of common stock of the surviving corporation)) will be converted into the right to receive $9.00 per share in cash, without interest.

 

Rite Aid and WBA and Victoria Merger Sub have each made customary representations, warranties and covenants in the Merger Agreement, including, among other things, that (i) Rite Aid and its subsidiaries will continue to conduct our business in the ordinary course consistent with past practice between the execution of the Merger Agreement and the closing of the Merger and (ii) Rite Aid will not solicit proposals relating to alternative transactions to the Merger or engage in discussions or negotiations with

 

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respect thereto, subject to certain exceptions. Additionally, the Merger Agreement limits the Company’s ability to incur indebtedness for borrowed money and issue additional capital stock, among other things.

 

On October 19, 2016, in accordance with the terms of the Merger Agreement, the Company and WBA jointly agreed to extend the “End Date” (as defined in the Merger Agreement) to January 27, 2017.

 

On December 19, 2016, the Company entered into an Asset Purchase Agreement (the “Asset Purchase Agreement”) with AFAE, LLC, a Tennessee limited liability company (“Buyer”), Fred’s (solely for the purposes set forth in the Asset Purchase Agreement) and WBA (solely for the purposes set forth in the Asset Purchase Agreement).  Pursuant to the terms and subject to the conditions set forth in the Asset Purchase Agreement, Buyer will purchase from the Company 865 stores (the “Acquired Stores”) and certain specified assets related thereto for a purchase price of $950,000 plus Buyer’s assumption of certain liabilities of the Company and its affiliates (the “Sale”).

 

Completion of the Sale is subject to various closing conditions, including but not limited to (i) the closing of the proposed acquisition of the Company by WBA (the “Rite Aid Acquisition”), (ii) the Federal Trade Commission (“FTC”) having issued publicly the proposed final judgment relating to the Acquired Stores in connection with the Rite Aid Acquisition identifying Buyer as being preliminarily approved as the purchaser of the assets purchased under the Asset Purchase Agreement, (iii) filings with or receipt of approval from the applicable state boards of pharmacy, and (iv) the absence of a material adverse effect on the stores being acquired in the Sale.

 

The parties to the Asset Purchase Agreement have each made customary representations and warranties. The Company has agreed to various covenants and agreements, including, among others, the Company’s agreement to conduct its business at the Acquired Stores in the ordinary course during the period between the execution of the Asset Purchase Agreement and the closing of the Sale, subject to certain exceptions.  Fred’s and Buyer have also agreed to various covenants and agreements in the Asset Purchase Agreement, including, among other things, (i) Fred’s and Buyer’s agreement to use their reasonable best efforts to obtain all authorizations and approvals from governmental authorities and (ii) Fred’s and Buyer’s agreement to (x) prepare and furnish all necessary information and documents reasonably requested by the FTC, (y) use reasonable best efforts to demonstrate to the FTC that each of Fred’s and Buyer is an acceptable purchaser of, and will compete effectively using, the assets purchased in the Sale, and (z) reasonably cooperate with WBA and the Company in obtaining all FTC approvals.  In the event that the FTC requests changes to the Asset Purchase Agreement, the parties agreed to negotiate in good faith to make the necessary changes.  To the extent the FTC requests that additional stores be sold, and WBA agrees to sell such stores, each of Fred’s and Buyer has agreed to buy those stores.

 

The Asset Purchase Agreement contains specified termination rights for the Company, WBA and Buyer, including a mutual termination right (i) in the event of the issuance of a final, nonappealable governmental order permanently restraining the Sale or (ii) in the event that the Merger Agreement is terminated in accordance with its terms.  WBA has additional termination rights, if, among others thing, (i) Buyer or Fred’s is not preliminarily approved by the FTC or other necessary governmental authority as purchaser of the assets in the Sale or (ii) the FTC informs WBA or its affiliates in writing that the Director of the Bureau of Competition will not recommend approval of Fred’s or Buyer as purchaser of the assets in the Sale.

 

While WBA is actively engaged in discussions with the FTC regarding the transaction and is working towards a close of the Merger in early calendar 2017, there can be no assurance that the requisite regulatory approvals will be obtained, or that the Merger or the Sale will be completed within the time periods contemplated by the Merger Agreement and Asset Purchase Agreement.

 

4. 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						Thirty-Nine Week Period Ended
		November 26, 2016			November 28, 2015			November 26, 2016			November 28, 2015
Numerator for income per share:
Income attributable to common stockholders—basic and diluted		$	15,010		$	59,543		$	25,195		$	99,848
Denominator:
Basic weighted average shares		1,045,028			1,039,867			1,043,887			1,018,783
Outstanding options and restricted shares, net		15,735			17,411			17,117			18,765
Diluted weighted average shares		1,060,763			1,057,278			1,061,004			1,037,548
Basic and diluted income per share		$	0.01		$	0.06		$	0.02		$	0.10

 

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Due to their antidilutive effect, 3,320 and 3,534 potential common shares related to stock options have been excluded from the computation of diluted income per share as of November 26, 2016 and November 28, 2015, respectively.

 

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.

 

5. Lease Termination and Impairment Charges

 

Lease termination and impairment charges consist of amounts as follows:

 

		Thirteen Week Period Ended						Thirty-Nine Week Period Ended
		November 26, 2016			November 28, 2015			November 26, 2016			November 28, 2015
Impairment charges		$	957		$	540		$	1,654		$	818
Lease termination charges		6,308			6,471			18,625			20,852
		$	7,265		$	7,011		$	20,279		$	21,670

 

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						Thirty-Nine Week Period Ended
		November 26, 2016			November 28, 2015			November 26, 2016			November 28, 2015
Balance—beginning of period		$	190,708		$	223,667		$	208,421		$	241,047
Provision for present value of noncancellable lease payments of closed stores		2,725			438			5,877			6,410
Changes in assumptions about future sublease income, terminations and changes in interest rates		137			2,000			2,044			2,434
Interest accretion		3,482			4,033			10,878			12,553
Cash payments, net of sublease income		(17,073		)	(15,502		)	(47,241		)	(47,808		)
Balance—end of period		$	179,979		$	214,636		$	179,979		$	214,636

 

6. 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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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 thirty-nine week period ended November 26, 2016, long-lived assets from continuing operations with a carrying value of $3,544, primarily store assets, were written down to their fair value of $1,890, resulting in an impairment charge of $1,654 of which $957 relates to the thirteen week period ended November 26, 2016. During the thirty-nine week period ended November 28, 2015, long-lived assets from continuing operations with a carrying value of $5,125, primarily store assets, were written down to their fair value of $4,307, resulting in an impairment charge of $818 of which $540 relates to the thirteen week period ended November 28, 2015. 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 November 26, 2016 and November 28, 2015:

 

Fair Value Measurement Using

 

		Level 1			Level 2			Level 3			Total as of November 26, 2016
Long-lived assets held for use		$	—		$	—		$	867		$	867
Long-lived assets held for sale		$	—		$	1,023		$	—		$	1,023
Total		$	—		$	1,023		$	867		$	1,890

 

		Level 1			Level 2			Level 3			Total as of November 28, 2015
Long-lived assets held for use		$	—		$	—		$	1,747		$	1,747
Long-lived assets held for sale		$	—		$	2,371		$	189		$	2,560
Total		$	—		$	2,371		$	1,936		$	4,307

 

As of November 26, 2016 and November 28, 2015, 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 $6,893 of investments, carried at amortized cost as these investments are being held to maturity, which are included as a component of prepaid expenses and other current assets as of November 26, 2016.  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 $7,208,376 and $7,576,833, respectively, as of November 26, 2016. There were no outstanding derivative financial instruments as of November 26, 2016 and February 27, 2016.

 

7. Income Taxes

 

The Company recorded an income tax benefit of $8,087 and an income tax expense of $48,468 for the thirteen week periods ended November 26, 2016 and November 28, 2015, respectively, and an income tax benefit of $3,468 and an income tax expense of $77,372 for the thirty-nine week periods ended November 26, 2016 and November 28, 2015, respectively.  The income tax benefit for the thirteen week period ended November 26, 2016 and the income tax expense for the thirteen week period ended November 28, 2015 resulted in a tax rate of (116.8)% and 44.9%, respectively.  The income tax benefit for the thirty-nine week period ended

 

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November 26, 2016 and the income tax expense for the thirty-nine week period ended November 28, 2015 resulted in a tax rate of (16.0)% and 43.7%, respectively.  The tax benefit for the thirteen and thirty-nine week periods ended November 26, 2016 was the result of lower projected earnings for the Retail Pharmacy segment which resulted in a cumulative adjustment to the annual effective tax rate.

 

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. The Company continues to maintain a valuation allowance against net deferred tax assets of $215,448 and $212,023, which relates primarily to state deferred tax assets at November 26, 2016 and February 27, 2016, respectively.

 

8. Medicare Part D

 

The Company offers Medicare Part D benefits through EIC, which has contracted with CMS to be a Prescription Drug Plan (“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 $29,331 as of September 30, 2016. EIC was in excess of the minimum required amounts in these states as of November 26, 2016.

 

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 November 26, 2016, accounts receivable, net included $193,238 due from CMS and accrued salaries, wages and other current liabilities included $106,205 of EIC liabilities under certain reinsurance contracts. As of February 27, 2016, accounts receivable, net included $275,032 due from CMS and accrued salaries, wages and other current liabilities included $166,238 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.

 

9. Goodwill and Other Intangible Assets

 

Goodwill and indefinitely-lived 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 thirteen and thirty-nine week periods ended November 26, 2016 and the fifty-two week period ended February 27, 2016, no impairment charges have been taken against the Company’s goodwill or indefinitely-lived intangible assets. Below is a summary of the changes in the carrying amount of goodwill for the thirty-nine week period ended November 26, 2016:

 

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		November 26, 2016
		Retail Pharmacy			Pharmacy Services			Total
Balance, February 27, 2016		$	76,124		$	1,637,351		$	1,713,475
Acquisition (see Note 2. Acquisition)
Change in goodwill resulting from changes to the final purchase price allocation		—			2,004			2,004
Balance, November 26, 2016		$	76,124		$	1,639,355		$	1,715,479

 

The Company’s 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 November 26, 2016 and February 27, 2016.

 

		November 26, 2016											February 27, 2016
		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		$	672,470		$	(530,124	)	$	142,346		7 years		$	665,197		$	(507,776	)	$	157,421		8 years
Prescription files		1,578,079			(1,364,143		)	213,936			3 years		1,541,518			(1,285,633		)	255,885			3 years
Customer relationships(a)		465,000			(93,991		)	371,009			16 years		465,000			(44,203		)	420,797			17 years
CMS license		57,500			(3,297		)	54,203			24 years		57,500			(1,572		)	55,928			25 years
Claims adjudication and other developed software		59,082			(12,081		)	47,001			6 years		59,000			(5,760		)	53,240			7 years
Trademarks		20,100			(2,881		)	17,219			9 years		20,100			(1,373		)	18,727			10 years
Backlog		11,500			(5,494		)	6,006			2 years		11,500			(2,619		)	8,881			3 years
Total finite		$	2,863,731		$	(2,012,011	)	851,720					$	2,819,815		$	(1,848,936	)	970,879
Trademarks		33,500			—			33,500			Indefinite		33,500			—			33,500			Indefinite
Total		$	2,897,231		$	(2,012,011	)	$	885,220				$	2,853,315		$	(1,848,936	)	$	1,004,379

 

(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 November 26, 2016 and February 27, 2016 are unfavorable lease intangibles with a net carrying amount of $41,820 and $46,947, 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 $55,625 and $166,536 for the thirteen and thirty-nine week periods ended November 26, 2016, respectively. Amortization expense for these intangible assets and liabilities was $54,338 and $134,888 for the thirteen and thirty-nine week periods ended November 28, 2015, respectively. The anticipated annual amortization expense for these intangible assets and liabilities is 2017—$217,982; 2018—$178,909; 2019—$141,415; 2020—$111,826 and 2021—$79,109.

 

10. Indebtedness and Credit Agreements

 

Following is a summary of indebtedness and lease financing obligations at November 26, 2016 and February 27, 2016:

 

		November 26, 2016			February 27, 2016
Secured Debt:
Senior secured revolving credit facility due January 2020 ($2,380,000 and $2,100,000 face value less unamortized debt issuance costs of $27,292 and $33,903)		$	2,352,708		$	2,066,097
Tranche 1 Term Loan (second lien) due August 2020 ($470,000 face value less unamortized debt issuance costs of $4,496 and $5,414)		465,504			464,586
Tranche 2 Term Loan (second lien) due June 2021 ($500,000 face value less unamortized debt issuance costs of $2,584 and $3,007)		497,416			496,993
Other secured		90			90
		3,315,718			3,027,766
Guaranteed Unsecured Debt:
9.25% senior notes due March 2020 ($902,000 face value plus unamortized premium of $2,239 and $2,743 and less unamortized debt issuance costs of $8,228 and $10,180)		896,011			894,563
6.75% senior notes due June 2021 ($810,000 face value less unamortized debt issuance costs of $6,759 and $7,872)		803,241			802,128
6.125% senior notes due April 2023 ($1,800,000 face value less unamortized debt issuance costs of $27,135 and $30,343)		1,772,865			1,769,657
		3,472,117			3,466,348

 

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		November 26, 2016			February 27, 2016
Unguaranteed Unsecured Debt:
7.7% notes due February 2027 ($295,000 face value less unamortized debt issuance costs of $1,670 and $1,794)		293,330			293,206
6.875% fixed-rate senior notes due December 2028 ($128,000 face value less unamortized debt issuance costs of $789 and $837)		127,211			127,163
		420,541			420,369
Lease financing obligations		66,534			79,653
Total debt		7,274,910			6,994,136
Current maturities of long-term debt and lease financing obligations		(22,681		)	(26,848		)
Long-term debt and lease financing obligations, less current maturities		$	7,252,229		$	6,967,288

 

Credit Facility

 

The Company’s senior secured credit facility (“Amended and Restated Senior Secured Credit Facility” or “revolver”) has a borrowing capacity of $3,700,000 and matures in January 2020. Borrowings under the revolver bear interest at a rate per annum between (i) LIBOR plus 1.50% and LIBOR plus 2.00% with respect to Eurodollar borrowings and (ii) the alternate base rate plus 0.50% and the alternate base rate plus 1.00% with respect to ABR borrowings, in each case, based upon the average revolver availability (as defined in the Amended and Restated Senior Secured Credit Facility). 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.

 

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 November 26, 2016, the Company had $2,380,000 of borrowings outstanding under the revolver and had letters of credit outstanding against the revolver of $64,866, which resulted in additional borrowing capacity of $1,255,134. The Merger Agreement contains a requirement that the Company’s borrowings under the revolver not exceed $3,000,000 in the aggregate immediately prior to the closing of the Merger.

 

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.

 

The Amended and Restated Senior Secured Credit Facility allows the Company to have outstanding, at any time, up to $1,500,000 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.

 

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

 

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which availability under the revolving credit facility is equal to or greater than $250,000. As of November 26, 2016, 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 subsidiaries is presented for those periods subsequent to the Acquisition. See Note 16 “Guarantor and Non-Guarantor Condensed Consolidating Financial Information” for additional disclosure.

 

Other Transactions

 

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. 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.

 

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 repaid 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 2017 and thereafter are as follows: 2017—$90; 2018—$0; 2019—$0; 2020—$2,380,000; 2021—$1,372,000 and $3,533,000 thereafter.

 

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11. 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 thirty-nine week periods ended November 26, 2016 and November 28, 2015 include $36,766 and $26,529, 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 thirty-nine week periods ended November 26, 2016 and November 28, 2015, the Company incurred $14,448 and $7,996 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 thirty-nine week periods ended November 26, 2016 and November 28, 2015 are as follows:

 

		November 26, 2016					November 28, 2015
		Shares		Weighted Average Fair Value			Shares		Weighted Average Fair Value
Stock options granted		—		$	N/A		3,579		$	4.45
Restricted stock awards granted		3,613		$	7.73		2,750		$	8.60
Total awards		3,613					6,329

 

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:

 

		Thirty-Nine Week Period Ended
		November 26, 2016		November 28, 2015
Expected stock price volatility		N/A		56	%
Expected dividend yield		N/A		0	%
Risk-free interest rate		N/A		1.7	%
Expected option life		N/A		5.5 years

 

As of November 26, 2016, 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:

 

		November 26, 2016
		Unvested stock options			Unvested restricted stock			Unvested performance shares
Unrecognized pre-tax costs		$	14,865		$	37,183		$	28,135
Weighted average amortization period		2.1 years			2.1 years			1.7 years

 

12. 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 thirty-nine week periods ended November 26, 2016 and November 28, 2015:

 

		Thirteen Week Period Ended November 26, 2016						Thirteen Week Period Ended November 28, 2015						Thirty-Nine Week Period Ended November 26, 2016						Thirty-Nine Week Period Ended November 28, 2015
		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		$	(46,419	)	$	(46,419	)	$	(44,655	)	$	(44,655	)	$	(47,781	)	$	(47,781	)	$	(45,850	)	$	(45,850	)
Amounts reclassified from accumulated other comprehensive loss to net income, net of $451, $398, $1,353, and $1,194 tax expense		681			681			597			597			2,043			2,043			1,792			1,792
Balance-end of period		$	(45,738	)	$	(45,738	)	$	(44,058	)	$	(44,058	)	$	(45,738	)	$	(45,738	)	$	(44,058	)	$	(44,058	)

 

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