RITE AID CORP - Quarter Report: 2017 September (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 September 2, 2017

 

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, smaller reporting company, or an emerging growth company. See the definitions of “Large Accelerated Filer,” “Accelerated Filer,” “Smaller Reporting Company” and “Emerging Growth Company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer x

Accelerated Filer o

Non-Accelerated Filer o (Do not check if a smaller reporting company)

Smaller reporting company o Emerging growth companyo

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

 

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

 

The registrant had 1,063,959,987 shares of its $1.00 par value common stock outstanding as of September 22, 2017.

 

 

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RITE AID CORPORATION

 

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	Cautionary Statement Regarding Forward-Looking Statements	3
	PART I FINANCIAL INFORMATION
ITEM 1.	Financial Statements (unaudited):
	Condensed Consolidated Balance Sheets as of September 2, 2017 and March 4, 2017	5
	Condensed Consolidated Statements of Operations for the Thirteen Week Periods Ended September 2, 2017 and August 27, 2016	6
	Condensed Consolidated Statements of Comprehensive Income for the Thirteen Week Periods Ended September 2, 2017 and August 27, 2016	7
	Condensed Consolidated Statements of Operations for the Twenty-Six Week Periods Ended September 2, 2017 and August 27, 2016	8
	Condensed Consolidated Statements of Comprehensive Income for the Twenty-Six Week Periods Ended September 2, 2017 and August 27, 2016	9
	Condensed Consolidated Statements of Cash Flows for the Twenty-Six Week Periods Ended September 2, 2017 and August 27, 2016	10
	Notes to Condensed Consolidated Financial Statements	11
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	33
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	45
ITEM 4.	Controls and Procedures	46
	PART II OTHER INFORMATION
ITEM 1.	Legal Proceedings	47
ITEM 1A.	Risk Factors	47
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
ITEM 3.	Defaults Upon Senior Securities	47
ITEM 4.	Mine Safety Disclosures	48
ITEM 5.	Other Information	48
ITEM 6.	Exhibits	49

 

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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 through 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 impact of the loss of one or more major third party payors;

 

·                  the inability to complete the proposed Sale (as defined in Note 3 below) due to the failure to satisfy the conditions to the completion of the Sale, including receipt of required regulatory approvals, and other risks related to obtaining the requisite consents to the Sale;

 

·                  the impact on our business as a result of, and the uncertainty related to the completion of, a transaction with Walgreens Boots Alliance, Inc. (“WBA”) over the past two years (including the attempted merger (the “Merger”) pursuant to the terminated Merger Agreement, dated as of  October 27, 2015, with WBA and Victoria Merger Sub, Inc. (as amended by Amendment No. 1 thereto, dated as of January 29, 2017, the “Merger Agreement”), the attempted asset sale pursuant to the Original APA (as defined below) and the proposed Sale), including on our business relationships (including, without limitation, customers, suppliers and employees), operating results and business generally. The initial attempts to sell the Company pursuant to the Merger Agreement and to sell a number of stores to WBA pursuant to the Original APA were not able to obtain regulatory approval and resulted in the entry into the Amended and Restated Asset Purchase Agreement for a smaller number of stores;

 

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

 

·                  our ability to refinance our indebtedness on terms favorable to us in the event that the Sale is not completed;

 

·                  the risk that a governmental entity may prohibit, delay or refuse to grant approval for the completion of the Sale or may require conditions, limitations or restrictions in connection with such approvals;

 

·                  there may be changes to our strategy in the event that the Sale does not close, which may include delaying or reducing capital or other expenditures, selling assets or other operations, closing underperforming stores, attempting to restructure or refinance our debt, seeking additional capital or incurring other costs associated with restructuring our business;

 

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

 

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

 

·                  our ability to hire and retain qualified personnel;

 

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

 

·                  our ability to manage expenses and working capital;

 

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

 

·                  the risk that changes in federal or state laws or regulations, including the Health Care Education Affordability Reconciliation Act, the repeal of all or part of the Patient Protection and the Affordable Care Act (or “Patient Care Act”) and any regulations enacted thereunder may occur;

 

·                  the risk that provider and state contract changes may occur;

 

·                  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;

 

·                  the continued impact of gross margin pressure 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;

 

·                  risks related to other business effects, including the effects of industry, market, economic, political or regulatory conditions, future exchange or interest rates or credit ratings, changes in tax laws, regulations, rates and policies or competitive development including aggressive promotional activity from our competitors;

 

·                  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 March 4, 2017 (the “Fiscal 2017 10-K”), which we filed with the SEC on May 3, 2017, and our Quarterly Report on Form 10-Q for the thirteen weeks ended June 3, 2017 (the “First Quarter 2018 10-Q”) which we filed on July 6, 2017, as well as in the “Risk Factors” section of the Fiscal 2017 10-K. 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)

 

		September 2, 2017			March 4, 2017
ASSETS
Current assets:
Cash and cash equivalents		$	238,978		$	245,410
Accounts receivable, net		1,843,320			1,771,126
Inventories, net of LIFO reserve of $1,022,282 and $999,776		2,877,427			2,837,211
Prepaid expenses and other current assets		221,644			211,541
Total current assets		5,181,369			5,065,288
Property, plant and equipment, net		2,188,217			2,251,692
Goodwill		1,715,479			1,715,479
Other intangibles, net		747,288			835,795
Deferred tax assets		1,453,291			1,505,564
Other assets		212,664			219,934
Total assets		$	11,498,308		$	11,593,752
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt and lease financing obligations		$	22,491		$	21,335
Accounts payable		1,687,880			1,613,909
Accrued salaries, wages and other current liabilities		1,270,840			1,370,004
Total current liabilities		2,981,211			3,005,248
Long-term debt, less current maturities		7,082,549			7,263,288
Lease financing obligations, less current maturities		37,890			44,070
Other noncurrent liabilities		663,048			667,076
Total liabilities		10,764,698			10,979,682
Commitments and contingencies		—			—
Stockholders’ equity:
Common stock, par value $1 per share; 1,500,000 shares authorized; shares issued and outstanding 1,062,411 and 1,053,690		1,062,411			1,053,690
Additional paid-in capital		4,841,700			4,839,854
Accumulated deficit		(5,129,213		)	(5,237,157		)
Accumulated other comprehensive loss		(41,288		)	(42,317		)
Total stockholders’ equity		733,610			614,070
Total liabilities and stockholders’ equity		$	11,498,308		$	11,593,752

 

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
		September 2, 2017			August 27, 2016
Revenues		$	7,678,903		$	8,029,806
Costs and expenses:
Cost of revenues		5,891,900			6,113,063
Selling, general and administrative expenses		1,734,306			1,778,247
Lease termination and impairment charges		3,128			7,233
Interest expense		111,261			105,388
Walgreens Boots Alliance merger termination fee		(325,000		)	—
(Gain) loss on sale of assets, net		(14,495		)	174
		7,401,100			8,004,105
Income before income taxes		277,803			25,701
Income tax expense		107,087			10,928
Net income		$	170,716		$	14,773
Computation of income attributable to common stockholders:
Income attributable to common stockholders—basic and diluted		$	170,716		$	14,773
Basic and diluted income per share		$	0.16		$	0.01

 

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
		September 2, 2017			August 27, 2016
Net income		$	170,716		$	14,773
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 $342 and $451 tax expense		515			681
Total other comprehensive income		515			681
Comprehensive income		$	171,231		$	15,454

 

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
		September 2, 2017			August 27, 2016
Revenues		$	15,460,356		$	16,213,987
Costs and expenses:
Cost of revenues		11,914,319			12,402,944
Selling, general and administrative expenses		3,495,596			3,571,494
Lease termination and impairment charges		7,214			13,014
Interest expense		221,198			210,501
Walgreens Boots Alliance merger termination fee		(325,000		)	—
(Gain) loss on sale of assets, net		(20,216		)	1,230
		15,293,111			16,199,183
Income before income taxes		167,245			14,804
Income tax expense		71,878			4,619
Net income		$	95,367		$	10,185
Computation of income attributable to common stockholders:
Income attributable to common stockholders—basic and diluted		$	95,367		$	10,185
Basic and diluted income per share		$	0.09		$	0.01

 

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
		September 2, 2017			August 27, 2016
Net income		$	95,367		$	10,185
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 $684 and $902 tax expense		1,029			1,362
Total other comprehensive income		1,029			1,362
Comprehensive income		$	96,396		$	11,547

 

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
		September 2, 2017			August 27, 2016
Operating activities:
Net income		$	95,367		$	10,185
Adjustments to reconcile to net cash provided by operating activities:
Depreciation and amortization		274,104			280,839
Lease termination and impairment charges		7,214			13,014
LIFO charge		22,506			27,511
(Gain) loss on sale of assets, net		(20,216		)	1,230
Stock-based compensation expense		15,362			23,696
Changes in deferred taxes		64,850			1,998
Excess tax benefit on stock options and restricted stock		—			(3,248		)
Changes in operating assets and liabilities:
Accounts receivable		(73,782		)	(227,255		)
Inventories		(62,714		)	(157,471		)
Accounts payable		62,552			150,339
Other assets and liabilities, net		(87,412		)	(101,799		)
Net cash provided by operating activities		297,831			19,039
Investing activities:
Payments for property, plant and equipment		(120,461		)	(225,718		)
Intangible assets acquired		(13,073		)	(28,869		)
Proceeds from dispositions of assets and investments		17,407			6,833
Proceeds from insured loss		3,627			—
Net cash used in investing activities		(112,500		)	(247,754		)
Financing activities:
Net (payments to) proceeds from revolver		(190,000		)	250,000
Principal payments on long-term debt		(8,096		)	(11,230		)
Change in zero balance cash accounts		10,189			534
Net proceeds from issuance of common stock		215			3,958
Excess tax benefit on stock options and restricted stock		—			3,248
Payments for taxes related to net share settlement of equity awards		(4,071		)	(6,173		)
Net cash (used in) provided by financing activities		(191,763		)	240,337
(Decrease) increase in cash and cash equivalents		(6,432		)	11,622
Cash and cash equivalents, beginning of period		245,410			124,471
Cash and cash equivalents, end of period		$	238,978		$	136,093
Supplementary cash flow data:
Cash paid for interest (net of capitalized amounts of $184 and $101, respectively)		$	208,909		$	199,966
Cash payments of income taxes, net of refunds		$	3,119		$	5,628
Equipment financed under capital leases		$	8,615		$	2,860
Equipment received for noncash consideration		$	1,295		$	746
Reduction in lease financing obligation		$	4,740		$	—
Gross borrowings from revolver		$	1,471,000		$	1,937,000
Gross payments to revolver		$	1,661,000		$	1,687,000

 

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 September 2, 2017 and August 27, 2016

 

(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 September 2, 2017 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 2017 10-K.

 

Recently Adopted Accounting Pronouncements

 

In March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation, (Topic 718): Improvements to Employee Share-Based Payment Accounting, which amends the accounting for certain aspects of share-based payments to employees in ASC Topic 718, Compensation — Stock Compensation. The new guidance eliminates the accounting for any excess tax benefits and deficiencies through equity and requires all excess tax benefits and deficiencies related to employee share-based compensation arrangements to be recorded in the income statement. This aspect of the new guidance is required to be applied prospectively. The new guidance also requires (i.) the presentation of excess tax benefits on the statement of cash flows as an operating activity rather than a financing activity, a change which may be applied prospectively or retrospectively and (ii.) the presentation of employee taxes paid when an employer withholds shares for tax withholding purposes on the statement of cash flows as a financing activity, a change which must be applied retrospectively. The new guidance further provides an accounting policy election to account for forfeitures as they occur rather than utilizing the estimated amount of forfeitures at the time of issuance. The Company adopted this new guidance effective March 5, 2017. The primary impact of adoption was (i.) the modified retrospective recognition of the cumulative amount of previously unrecognized excess tax benefits as an opening balance sheet adjustment and (ii.) the recognition of excess tax benefits in the income statement on a prospective basis, rather than equity. As a result, the Company (i.) increased the deferred tax asset and reduced accumulated deficit by $12,577 as of the beginning of the twenty-six weeks ended September 2, 2017, and (ii.) the Company recognized a discrete income tax expense of $9,653 in income tax expense for the twenty-six weeks ended September 2, 2017. The Company also elected to adopt the cash flow presentation of the excess tax benefits prospectively commencing in the first quarter of fiscal 2018. The retrospective application of cash paid on employees’ behalf related to shares withheld for tax purposes resulted in an increase to “Net cash provided by operating activities” and a decrease to “Net cash provided by financing activities” of $6,173 for the twenty-six weeks ended August 27, 2016. The Company’s stock-based compensation expense continues to reflect estimated forfeitures. None of the other provisions in this new guidance had a material impact on the Company’s condensed consolidated financial statements.

 

Recently Issued Accounting Pronouncements Not Yet Adopted

 

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 does not intend to early adopt the new standard. The Company assembled a cross

 

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functional team to identify the population of contracts with customers, for both its Retail Pharmacy and Pharmacy Services segments, and evaluate them under the provisions of ASU 2014-09. The Company intends to adopt the new standard on a modified retrospective basis. Under this implementation method, the Company will recognize the cumulative effect of initially applying the new guidance as an adjustment to the opening retained earnings balance for the annual reporting period of initial application. While the Company is continuing its assessment of all of the potential impacts of the new standard, it does not expect the implementation of the standard to have a material impact on the Company’s consolidated financial position, results of operations or 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 (fiscal 2020). The Company believes that the new standard will have a material impact on its financial position. The Company is currently evaluating the impact this standard implementation will have on its results of operations and cash flows.

 

In January 2017, the FASB issued ASU No. 2017-04, Intangibles—Goodwill and Other, (Topic 350): Simplifying the Test for Goodwill Impairment, which is intended to simplify the subsequent measurement and impairment of goodwill. The ASU simplifies the complexity of evaluating goodwill for impairment by eliminating the second step of the impairment test, which compares the implied fair value of a reporting unit’s goodwill to the carrying amount of that goodwill. Instead, the ASU requires entities to compare the fair value of a reporting unit to its carrying amount in order to determine the amount of goodwill impairment recognized. ASU No. 2017-04 is effective for fiscal years and interim periods within those years beginning after December 15, 2019 (fiscal 2020). Early adoption of all the amendments for ASU 2017-04 is permitted. Amendments must be applied prospectively. The Company is in process of assessing the impact of the adoption of ASU No. 2017-04 on its financial position, results of operations and cash flows.

 

2. Acquisition

 

On June 24, 2015, the Company acquired 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 has been rebranded as EnvisionRxOptions (“EnvisionRx” or “EnvisionRxOptions”), 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 twenty-six week periods ended September 2, 2017 and August 27, 2016 include EnvisionRx results of operations (please see Note 13 Segment Reporting for the Pharmacy Services segment results included within the condensed consolidated financial statements for the thirteen and twenty-six week periods ended September 2, 2017 and August 27, 2016, which reflects the results of EnvisionRx). The Company’s condensed consolidated financial statements reflect the 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.

 

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During fiscal 2017, the Company finalized the valuation of the identifiable assets acquired and the liabilities assumed. The following is the allocation of the purchase price:

 

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 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.

 

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3. Pending Asset Sale to WBA

 

Termination of Merger Agreement with WBA

 

On June 28, 2017, Rite Aid, WBA and Victoria Merger Sub, Inc. entered into a Termination Agreement (the “Merger Termination Agreement”) under which the parties agreed to terminate the Merger Agreement.  The Merger Termination Agreement provides that WBA would pay to Rite Aid a termination fee in the amount of $325,000. Rite Aid received the termination fee payment on June 30, 2017.  Subject to limited customary exceptions, the Merger Termination Agreement also mutually releases the parties from any claims of liability to one another relating to the contemplated Merger.

 

Entry Into Amended and Restated Asset Purchase Agreement with WBA

 

On September 18, 2017, the Company entered into an Amended and Restated Asset Purchase Agreement (the “Amended and Restated Asset Purchase Agreement”) with WBA and Walgreen Co., an Illinois corporation and wholly owned direct subsidiary of WBA (“Buyer”), which amends and restates in its entirety the previously disclosed Asset Purchase Agreement (the “Original APA”), dated as of June 28, 2017, by and among the Company, WBA and Buyer.  Pursuant to the terms and subject to the conditions set forth in the Amended and Restated Asset Purchase Agreement, Buyer will purchase from the Company 1,932 stores (the “Acquired Stores”) (reduced from 2,186 Rite Aid stores in the Original APA), three (3) distribution centers, related inventory and other specified assets related thereto for a purchase price of approximately $4.375 billion (reduced from $5.175 billion in the Original APA), on a cash-free, debt-free basis (the “Sale”).

 

The Company announced on September 19, 2017 that the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the “HSR Act”), expired with respect to the Sale.  The expiration of the waiting period under the HSR Act satisfies one of the conditions to the closing of the Sale.  Completion of the Sale remains subject to various closing conditions, including but not limited to (i)  the absence of a material adverse effect on the stores and distribution centers being acquired in the Sale and (ii) a duplicate copy of the Company’s key information technology systems and prescription dispensing system being operational.

 

The parties to the Amended and Restated 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 Amended and Restated Asset Purchase Agreement and the closing of the Sale, subject to certain exceptions, and the parties’ agreement to use their reasonable best efforts to obtain all authorizations and approvals from governmental authorities.  The Company has agreed to provide transition services to Buyer for up to (3) three years after closing of the Sale.

 

The Amended and Restated Asset Purchase Agreement contains specified termination rights for the Company and WBA, including a mutual termination right in the event any court of competent jurisdiction or other governmental entity shall have issued a final and nonappealable legal restraint that prevents, makes illegal, prohibits, restrains or enjoins the completion of the Sale, and a termination right for WBA prior to the closing of the first set of stores in the Sale in the event the Company enters into an agreement to sell all of the remainder of Rite Aid or over 50% of its stock or assets to a third party. In the event that the Company enters into an agreement to sell all of the remainder of Rite Aid or over 50% of its stock or assets to a third party prior to the end of the transition period under the Transition Services Agreement (“TSA”), any potential acquirer would be obligated to assume the Company’s remaining obligations under the TSA.  Under the terms of the Amended and Restated Asset Purchase Agreement, the Company has the option to purchase pharmaceutical drugs through an affiliate of WBA under terms, including cost, that are substantially equivalent to Walgreen’s for a period of ten (10) years, subject to certain terms and conditions.

 

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.

 

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		Thirteen Week Period Ended						Twenty-Six Week Period Ended
		September 2, 2017			August 27, 2016			September 2, 2017			August 27, 2016
Numerator for income per share:
Income attributable to common stockholders—basic and diluted		$	170,716		$	14,773		$	95,367		$	10,185
Denominator:
Basic weighted average shares		1,048,548			1,044,198			1,047,687			1,043,317
Outstanding options and restricted shares, net		18,668			17,251			22,597			17,210
Diluted weighted average shares		1,067,216			1,061,449			1,070,284			1,060,527
Basic and diluted income per share		$	0.16		$	0.01		$	0.09		$	0.01

 

Due to their antidilutive effect, 9,206 and 3,351 potential common shares related to stock options have been excluded from the computation of diluted income per share for the thirteen week period ended September 2, 2017 and August 27, 2016, respectively. Due to their antidilutive effect, 5,596 and 3,351 potential common shares related to stock options have been excluded from the computation of diluted income per share for the twenty-six week period ended September 2, 2017 and August 27, 2016, respectively.

 

5. Lease Termination and Impairment Charges

 

Lease termination and impairment charges consist of amounts as follows:

 

		Thirteen Week Period Ended						Twenty-Six Week Period Ended
		September 2, 2017			August 27, 2016			September 2, 2017			August 27, 2016
Impairment charges		$	35		$	78		$	694		$	697
Lease termination charges		3,093			7,155			6,520			12,317
		$	3,128		$	7,233		$	7,214		$	13,014

 

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
		September 2, 2017			August 27, 2016			September 2, 2017			August 27, 2016
Balance—beginning of period		$	155,666		$	198,990		$	165,138		$	208,421
Provision for present value of noncancellable lease payments of closed stores		—			2,530			913			3,152
Changes in assumptions about future sublease income, terminations and changes in interest rates		201			1,096			(348		)	1,907
Interest accretion		2,907			3,618			6,002			7,396
Cash payments, net of sublease income		(14,763		)	(15,526		)	(27,694		)	(30,168		)
Balance—end of period		$	144,011		$	190,708		$	144,011		$	190,708

 

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.

 

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·                  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.

 

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 September 2, 2017, long-lived assets from continuing operations with a carrying value of $999, primarily store assets, were written down to their fair value of $305, resulting in an impairment charge of $694 of which $35 relates to the thirteen week period ended September 2, 2017. During the twenty-six week period ended August 27, 2016, long-lived assets from continuing operations with a carrying value of $2,577, primarily store assets, were written down to their fair value of $1,880, resulting in an impairment charge of $697 of which $78 relates to the thirteen week period ended August 27, 2016.  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 September 2, 2017 and August 27, 2016:

 

Fair Value Measurement Using

 

		Level 1			Level 2			Level 3			Total as of September 2, 2017
Long-lived assets held for use		$	—		$	—		$	201		$	201
Long-lived assets held for sale		$	—		$	104		$	—		$	104
Total		$	—		$	104		$	201		$	305

 

		Level 1			Level 2			Level 3			Total as of August 27, 2016
Long-lived assets held for use		$	—		$	—		$	857		$	857
Long-lived assets held for sale		$	—		$	1,023		$	—		$	1,023
Total		$	—		$	1,023		$	857		$	1,880

 

As of September 2, 2017 and August 27, 2016, 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, as of September 2, 2017 the Company has $7,311 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 March 4, 2017 the Company has $6,874 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.  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 $7,082,639 and $7,147,454, respectively, as of September 2, 2017. There were no outstanding derivative financial instruments as of September 2, 2017 and March 4, 2017.

 

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7. Income Taxes

 

The Company recorded an income tax expense of $107,087 and $10,928 for the thirteen week periods ended September 2, 2017 and August 27, 2016, respectively, and an income tax expense of $71,878 and $4,619 for the twenty-six week periods ended September 2, 2017 and August 27, 2016, respectively.  The effective tax rate for the thirteen week periods ended September 2, 2017 and August 27, 2016 was 38.5% and 42.5%, respectively.  The effective tax rate for the twenty-six week periods ended September 2, 2017 and August 27, 2016 was 42.9% and 31.2%, respectively.  The effective tax rate for the thirteen and twenty-six week periods ended September 2, 2017 includes an adjustment of 3.0% and 10.4%, respectively, primarily related to the tax impact of the Walgreens Boots Alliance merger termination fee.  The lower effective income tax expense rate for the twenty-six week period ended August 27, 2016 is the result of a discrete income tax benefit recorded for the lapse of a statute of limitations on an uncertain tax position which lowered the Company’s effective income tax expense rate by 8.9%.

 

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 $234,706 and $226,726, which relates primarily to state deferred tax assets at September 2, 2017 and March 4, 2017, respectively.

 

8. Medicare Part D

 

The Company offers Medicare Part D benefits through EIC, which has contracted with Centers of Medicare and Medicaid Services (“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 $30,024 as of June 30, 2017. EIC was in excess of the minimum required amounts in these states as of September 2, 2017.

 

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 September 2, 2017, accounts receivable, net included $408,772 due from CMS and accrued salaries, wages and other current liabilities included $187,795 of EIC liabilities under certain reinsurance contracts. As of March 4, 2017, accounts receivable, net included $245,766 due from CMS and accrued salaries, wages and other current liabilities included $145,903 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 twenty-six weeks ended September 2, 2017 and

 

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the fifty-three weeks ended March 4, 2017, no impairment charges have been taken against the Company’s goodwill or indefinitely-lived intangible assets. No changes were made to the carrying amount of goodwill for the thirteen and twenty-six weeks ended September 2, 2017.

 

The Company’s intangible assets are primarily finite-lived and amortized over their useful lives. Following is a summary of the Company’s finite-lived and indefinite-lived intangible assets as of September 2, 2017 and March 4, 2017.

 

		September 2, 2017											March 4, 2017
		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		$	662,607		$	(543,508	)	$	119,099		7 years		$	664,670		$	(531,022	)	$	133,648		7 years
Prescription files		1,587,833			(1,427,409		)	160,424			3 years		1,584,240			(1,390,139		)	194,101			3 years
Customer relationships(a)		465,000			(142,643		)	322,357			15 years		465,000			(110,653		)	354,347			16 years
CMS license		57,500			(5,022		)	52,478			23 years		57,500			(3,872		)	53,628			24 years
Claims adjudication and other developed software		58,990			(18,402		)	40,588			5 years		58,995			(14,188		)	44,807			6 years
Trademarks		20,100			(4,389		)	15,711			8 years		20,100			(3,383		)	16,717			9 years
Backlog		11,500			(8,369		)	3,131			1 year		11,500			(6,453		)	5,047			2 years
Total finite		$	2,863,530		$	(2,149,742	)	$	713,788				$	2,862,005		$	(2,059,710	)	$	802,295
Trademarks		33,500			—			33,500			Indefinite		33,500			—			33,500			Indefinite
Total		$	2,897,030		$	(2,149,742	)	$	747,288				$	2,895,505		$	(2,059,710	)	$	835,795

 

(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 September 2, 2017 and March 4, 2017 are unfavorable lease intangibles with a net carrying amount of $35,409 and $38,242, 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 $45,378 and $100,310 for the thirteen and twenty-six week periods ended September 2, 2017, respectively. Amortization expense for these intangible assets and liabilities was $55,409 and $110,912 for the thirteen and twenty-six week periods ended August 27, 2016, respectively. The anticipated annual amortization expense for these intangible assets and liabilities is 2018—$182,434; 2019—$145,638; 2020—$116,065; 2021—$83,505 and 2022—$54,574.

 

10. Indebtedness and Credit Agreements

 

Following is a summary of indebtedness and lease financing obligations at September 2, 2017 and March 4, 2017:

 

		September 2, 2017			March 4, 2017
Secured Debt:
Senior secured revolving credit facility due January 2020 ($2,240,000 and $2,430,000 face value less unamortized debt issuance costs of $20,511 and $24,918)		$	2,219,489		$	2,405,082
Tranche 1 Term Loan (second lien) due August 2020 ($470,000 face value less unamortized debt issuance costs of $3,555 and $4,167)		466,445			465,833
Tranche 2 Term Loan (second lien) due June 2021 ($500,000 face value less unamortized debt issuance costs of $2,149 and $2,431)		497,851			497,569
Other secured		90			90
		3,183,875			3,368,574
Guaranteed Unsecured Debt:
9.25% senior notes due March 2020 ($902,000 face value plus unamortized premium of $1,736 and $2,071 and less unamortized debt issuance costs of $6,226 and $7,527)		897,510			896,544
6.75% senior notes due June 2021 ($810,000 face value less unamortized debt issuance costs of $5,618 and $6,360)		804,382			803,640
6.125% senior notes due April 2023 ($1,800,000 face value less unamortized debt issuance costs of $23,846 and $25,984)		1,776,154			1,774,016
		3,478,046			3,474,200
Unguaranteed Unsecured Debt:
7.7% notes due February 2027 ($295,000 face value less unamortized debt issuance costs of $1,543 and $1,625)		293,457			293,375
6.875% fixed-rate senior notes due December 2028 ($128,000 face value less unamortized debt issuance costs of $739 and $771)		127,261			127,229
		420,718			420,604
Lease financing obligations		60,291			65,315
Total debt		7,142,930			7,328,693
Current maturities of long-term debt and lease financing obligations		(22,491		)	(21,335		)
Long-term debt and lease financing obligations, less current maturities		$	7,120,439		$	7,307,358

 

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Credit Facility

 

The Company’s Amended and Restated Senior Secured Credit Facility 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 September 2, 2017, the Company had $2,240,000 of borrowings outstanding under the revolver and had letters of credit outstanding against the revolver of $59,343 which resulted in additional borrowing capacity of $1,400,657.

 

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 revolver of more than $365,000.

 

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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 revolver is less than $200,000 or (b) on the third consecutive business day on which availability under the revolver 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 revolver is equal to or greater than $250,000. As of September 2, 2017, the Company had availability under its revolver of $1,400,657, its fixed charge coverage ratio was greater than 1.00 to 1.00, and the Company was in compliance with the senior secured credit facility’s financial covenant. The Amended and Restated Senior Secured Credit Facility also contains covenants which place restrictions on the incurrence of debt, the payments of dividends, sale of assets, mergers and acquisitions and the granting of liens.

 

The Amended and Restated Senior Secured Credit Facility also provides for customary events of default.

 

The Company also has two second priority secured term loan facilities, the Tranche 1 Term Loan and the Tranche 2 Term Loan. The Tranche 1 Term Loan matures on August 21, 2020 and currently bears 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 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 15 “Guarantor and Non-Guarantor Condensed Consolidating Financial Information” for additional disclosure.

 

Maturities

 

The aggregate annual principal payments of long-term debt for the remainder of fiscal 2018 and thereafter are as follows: 2018—$90; 2019—$0; 2020—$2,240,000; 2021—$1,372,000; 2022—$1,310,000 and $2,223,000 thereafter.

 

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 twenty-six week periods ended September 2, 2017 and August 27, 2016 include $15,362 and $23,696, 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 fiscal 2018, the Company issued performance units to certain of its associates. The performance units will be settled in cash based on the actual performance of the Company relative to certain financial performance goals and the stock price upon vesting. During the twenty-six week periods ended September 2, 2017 and August 27, 2016, the Company incurred $2,170 and $9,112 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 September 2, 2017 and August 27, 2016 are as follows:

 

		September 2, 2017					August 27, 2016
		Shares		Weighted Average Fair Value			Shares		Weighted Average Fair Value
Stock options granted		—		$	N/A		—		$	N/A
Restricted stock awards granted		11,241		$	2.31		3,613		$	7.73
Total awards		11,241					3,613

 

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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.

 

As of September 2, 2017, 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:

 

		September 2, 2017
		Unvested stock options			Unvested restricted stock			Unvested performance shares
Unrecognized pre-tax costs		$	8,151		$	41,478		$	15,104
Weighted average amortization period		1.5 years			2.3 years			2.5 years

 

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12. Retirement Plans

 

Net periodic pension expense recorded in the thirteen and twenty-six week periods ended September 2, 2017 and August 27, 2016, for the Company’s defined benefit plan includes the following components:

 

		Defined Benefit Pension Plan						Defined Benefit Pension Plan
		Thirteen Week Period Ended						Twenty-Six Week Period Ended
		September 2, 2017			August 27, 2016			September 2, 2017			August 27, 2016
Service cost		$	346		$	292		$	692		$	584
Interest cost		1,603			1,621			3,206			3,242
Expected return on plan assets		(1,147		)	(1,142		)	(2,294		)	(2,284		)
Amortization of unrecognized prior service cost		—			—			—			—
Amortization of unrecognized net loss		857			1,132			1,713			2,264
Net periodic pension expense		$	1,659		$	1,903		$	3,317		$	3,806

 

During the thirteen and twenty-six week period ended September 2, 2017 the Company contributed $0 to the Defined Benefit Pension Plan. During the remainder of fiscal 2018, the Company expects to contribute $4,900 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, collectively the “Parent Company”.

 

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, Chief Financial Officer, and Executive Vice Presidents-Retail Pharmacy, and the Chief Executive Officer—Pharmacy Services, and Executive Vice Presidents-Pharmacy Services (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 for the thirteen and twenty-six week periods ended September 2, 2017 and August 27, 2016:

 

		Retail Pharmacy			Pharmacy Services			Intersegment Eliminations (1)			Consolidated
Thirteen Week Period Ended
September 2, 2017:
Revenues		$	6,267,929		$	1,492,831		$	(81,857	)	$	7,678,903
Gross Profit		1,683,741			103,262			—			1,787,003
Adjusted EBITDA(2)		163,995			49,275			—			213,270
August 27, 2016:
Revenues		$	6,485,482		$	1,634,876		$	(90,552	)	$	8,029,806
Gross Profit		1,819,349			97,394			—			1,916,743
Adjusted EBITDA(2)		262,643			50,010			—			312,653
Twenty-Six Week Period Ended
September 2, 2017:
Revenues		$	12,618,137		$	3,006,072		$	(163,853	)	$	15,460,356
Gross Profit		3,337,803			208,234			—			3,546,037
Adjusted EBITDA(2)		307,960			97,874			—			405,834
August 27, 2016:
Revenues		$	13,161,030		$	3,237,235		$	(184,278	)	$	16,213,987
Gross Profit		3,624,716			186,327			—			3,811,043
Adjusted EBITDA(2)		507,470			91,185			—			598,655

 

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