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RAD > SEC Filings for RAD > Form 10-Q on 8-Jan-2014All Recent SEC Filings

Show all filings for RITE AID CORP

Form 10-Q for RITE AID CORP


8-Jan-2014

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

Net income for the thirteen and thirty-nine week periods ended November 30, 2013 was $71.5 million and $194.0 million, respectively, compared to a net income of $61.9 million and net loss of $5.0 million for the thirteen and thirty-nine week periods ended December 1, 2012, respectively. The improvement in the thirteen week operating results was driven primarily by lower interest expense and lease termination and impairment charges, partially offset by a higher LIFO charge and an $18.1 million benefit from the settlement of interchange fee litigation in the prior year. The improvement in the thirty-nine week operating results was driven primarily by higher gross profit from generic drugs, lower selling, general and administrative expenses ("SG&A"), and lower interest expense, partially offset by continued reimbursement rate pressures and a higher loss on debt retirement.

Adjusted EBITDA for the thirteen and thirty-nine week periods ended November 30, 2013 was $282.3 million and $968.6 million, respectively, compared to $295.3 million and $788.1 million for the thirteen and thirty-nine week periods ended December 1, 2012, respectively. Prior year Adjusted EBITDA included an $18.1 million benefit from the settlement of interchange fee litigation. The current quarter's Adjusted EBITDA benefited from an increase in pharmacy gross profit, driven by script count growth, generic purchasing efficiencies, and strong SG&A expense control, offset by a decrease in front-end gross profit. The improvement in Adjusted EBITDA for the thirty-nine week period ended November 30, 2013 was largely driven by increased pharmacy gross profit due to the continued benefit of generic introductions on pharmacy gross margin.

     Results of Operations

     Revenues and Other Operating Data

                       Thirteen Week Period Ended         Thirty-Nine Week Period Ended
                      November 30,      December 1,       November 30,       December 1,
                          2013              2012              2013               2012
                                            (dollars in thousands)
Revenues              $   6,357,732      $ 6,237,847     $    18,928,954     $ 18,937,018
Revenue growth
(decline)                       1.9 %           (1.2 )%              0.0 %           (0.2 )%
Same store sales
growth (decline)                2.3 %           (1.5 )%              0.3 %            0.3 %
Pharmacy sales
growth (decline)                3.0 %           (3.2 )%              0.0 %           (1.1 )%
Same store
prescription count
increase                        0.7 %            3.6 %               0.2 %            3.5 %
Same store
pharmacy sales
growth (decline)                3.5 %           (2.7 )%              0.4 %           (0.4 )%
Pharmacy sales as
a % of total sales             68.6 %           67.8 %              68.0 %           67.9 %
Third party sales
as a % of total
pharmacy sales                 97.1 %           96.5 %              97.0 %           96.6 %
Front-end sales
(decline) growth               (0.4 )%           0.7 %              (0.2 )%           1.2 %
Same store
front-end sales
(decline) growth               (0.2 )%           1.1 %               0.0 %            1.7 %
Front-end sales as
a % of total sales             31.4 %           32.2 %              32.0 %           32.1 %
Adjusted EBITDA(*)    $     282,262      $   295,284     $       968,629     $    788,102
Store data:
Total stores
(beginning of
period)                       4,604            4,643               4,623            4,667
New stores                        -                -                   -                -
Store acquisitions                -                -                   1                -
Closed stores                    (9 )            (10 )               (29 )            (34 )
Total stores (end
of period)                    4,595            4,633               4,595            4,633
Relocated stores                  4                3                   9                9
Remodeled and
expanded stores                  95              114                 312              404


--------------------------------------------------------------------------------
    (*)


See Adjusted EBITDA and Other Non-GAAP Measures for additional details


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Revenues

Revenues increased 1.9% for the thirteen weeks ended November 30, 2013 compared to a decrease of 1.2% for the thirteen weeks ended December 1, 2012. The increase in revenues for the thirteen week period ended November 30, 2013 was primarily a result of an increase in pharmacy same store sales. Pharmacy same store sales increased by 3.5% for the thirteen week period ended November 30, 2013 due primarily to brand drug inflation and the 0.7% increase in same store prescription count, partially offset by an approximate 0.9% negative impact from generic introductions and continued lower reimbursement rates. Front-end same store sales decreased by 0.2% in the thirteen week period ended November 30, 2013.

Revenues were flat and decreased 0.2% in the thirty-nine week periods ended November 30, 2013 and December 1, 2012, respectively. Revenue in the current year was favorably impacted by an increase in same store sales of 0.3% and same store prescription count increase of 0.2%, offset by store closings.

We include in same store sales all stores that have been open at least one year. Stores in liquidation are considered closed. Relocation stores are not included in same store sales until one year has lapsed.

     Costs and Expenses

                         Thirteen Week Period Ended        Thirty-Nine Week Period Ended
                        November 30,      December 1,      November 30,       December 1,
                            2013              2012             2013              2012
                                             (dollars in thousands)
Cost of goods sold      $    4,557,066     $ 4,426,526    $    13,490,936     $ 13,666,505
Gross profit                 1,800,666       1,811,321          5,438,018        5,270,513
Gross margin                      28.3 %          29.0 %             28.7 %           27.8 %
Selling, general and
administrative
expenses                     1,632,299       1,612,198          4,844,491        4,918,433
Selling, general and
administrative
expenses as a
percentage of
revenues                          25.7 %          25.9 %             25.6 %           26.0 %
Lease termination
and impairment
charges                          1,672          14,366             24,034           34,292
Interest expense               102,819         128,371            322,599          388,013

Cost of Goods Sold

Gross profit decreased $10.7 million for the thirteen week period ended November 30, 2013. Gross profit was negatively impacted by a higher LIFO charge. Pharmacy gross profit was higher due to the continued benefit of generic drug introductions, inflation on brand drugs, purchasing efficiencies on generic drugs and the 0.7% increase in same store prescription count, partially offset by continued reimbursement rate pressures. Front-end gross profit was lower due to lower sales and higher promotional markdowns.

Gross profit increased $167.5 million for the thirty-nine week period ended November 30, 2013. Pharmacy gross profit was higher due to the benefit of generic drug introductions and the 0.2% increase in same store prescription count, partially offset by continued reimbursement rate pressures. Front-end gross profit was lower due to higher tier discounts from our wellness + customer loyalty program and other markdowns, partially offset by higher vendor promotional funding. Gross profit was also positively impacted by a $23.5 million prescription drug antitrust litigation settlement in the first quarter, offset by a higher estimated LIFO charge due to higher estimated pharmacy inflation rates.

Gross margin was 28.3% and 28.7% of sales for the thirteen and thirty-nine week periods ended November 30, 2013, respectively, compared to 29.0% and 27.8% of sales for the thirteen and thirty-nine week periods ended December 1, 2012, respectively. The decline in gross margin for the thirteen week


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period was due primarily to higher promotional markdowns, continued reimbursement rate pressures and a higher LIFO charge. The improvement in gross margin for the thirty-nine week period was due primarily from generic drug introductions and higher vendor promotional funding. Offsetting these factors were continued reimbursement rate pressures, a higher LIFO expense, and increased promotional markdowns.

We use the last-in, first-out ("LIFO") method of inventory valuation, which is estimated on a quarterly basis and is finalized at year end when inflation rates and inventory levels are final. Therefore, LIFO costs for interim period financial statements are estimated. LIFO charges were $25.0 million and $60.0 million for the thirteen and thirty-nine week periods ended November 30, 2013 compared to no LIFO charge and a $27.5 million charge for the thirteen and thirty-nine week periods ended December 1, 2012. The higher estimated LIFO charge for this year relates to higher expected pharmacy inflation rates.

Selling, General and Administrative Expenses

SG&A as a percentage of revenues was 25.7% in the thirteen week period ended November 30, 2013 compared to 25.9% in the thirteen week period ended December 1, 2012. The decrease in SG&A as a percentage of revenues was due primarily to lower advertising expense, depreciation and amortization, and lower salaries as a percentage of revenues, partially offset by the prior year $18.1 million favorable settlement related to the payment card interchange fee litigation.

SG&A as a percentage of revenues was 25.6% in the thirty-nine week period ended November 30, 2013 compared to 26.0% in the thirty-nine week period ended December 1, 2012. The decrease in SG&A as a percentage of revenues for the thirty-nine week period was due primarily to the prior year reversal of $60.2 million of tax indemnification asset resulting from our settlement with the IRS associated with a pre-acquisition Brooks Eckerd tax audit, which was offset by an income tax benefit. In addition, SG&A decreased in the current year due to lower advertising, depreciation and amortization, and lower legal fees and litigation costs. These amounts are partially offset by increased salary and benefit costs.

     Lease Termination and Impairment Charges

    Lease termination and impairment charges consist of amounts as follows:

                                   Thirteen Week                  Thirty-Nine Week
                                   Period Ended                     Period Ended
                           November 30,     December 1,     November 30,      December 1,
                               2013            2012             2013             2012
 Impairment charges         $        335    $        339     $       5,201    $        882
 Lease termination
 charges                           1,337          14,027            18,833          33,410

                            $      1,672    $     14,366     $      24,034    $     34,292

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.

Please refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations-Impairment Charges" included in our Fiscal 2013 10-K for a detailed description of our impairment methodology.

Lease Termination Charges: Charges to close a store, which principally consist of continuing lease obligations, are recorded at the time the store is closed and all inventory is liquidated, pursuant to the


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guidance set forth in ASC 420, "Exit or Disposal Cost Obligations." We calculate our liability for closed stores on a store-by-store basis. The calculation includes the discounted effect of future minimum lease payments and related ancillary costs, from the date of closure to the end of the remaining lease term, net of estimated cost recoveries that may be achieved through subletting properties or through favorable lease terminations. We evaluate these assumptions each quarter and adjust the liability accordingly. As part of our ongoing business activities, we assess stores and distribution centers for potential closure and relocation. Decisions to close or relocate stores or distribution centers in future periods would result in charges for lease exit costs and liquidation of inventory, as well as impairment of assets at these locations.

Interest Expense

Interest expense was $102.8 million and $322.6 million for the thirteen and thirty-nine week periods ended November 30, 2013, respectively, compared to $128.4 million and $388.0 million for the thirteen and thirty-nine week periods ended December 1, 2012, respectively. The decrease in interest expense was the result of recent financings during the fourth quarter of fiscal 2013 and the first and second quarters of fiscal 2014. The weighted average interest rates on our indebtedness for the thirty-nine week periods ended November 30, 2013 and December 1, 2012 were 6.6% and 7.4%, respectively.

Income Taxes

We recorded an income tax expense of $1.4 million and $0.8 million for the thirteen week periods ended November 30, 2013 and December 1, 2012, respectively, and an income tax expense of $6.8 million and an income tax benefit of $63.8 million for the thirty-nine week periods ended November 30, 2013 and December 1, 2012, respectively. The income tax expense or benefit is recorded net of adjustments to maintain a full valuation allowance against our net deferred tax assets.

The income tax expense for the thirteen and thirty-nine week periods ended November 30, 2013 is primarily attributable to the accrual of federal, state and local taxes and adjustments to unrecognized tax benefits offset by adjustments to the valuation allowance of $(28.4) million and $(63.1) million, respectively.

The income tax expense for the thirteen week period ended December 1, 2012 was primarily attributable to an accrual of federal, state and local taxes and adjustments to unrecognized tax benefits offset by adjustments to the valuation allowance of $(24.7) million.

The income tax benefit for the thirty-nine week period ended December 1, 2012 was primarily attributable to the recognition of previously unrecognized tax benefits resulting from the appellate settlements of the Brooks Eckerd Internal Revenue Service (IRS) Audit of fiscal years 2004 - 2007 as well as the Commonwealth of Massachusetts Audit of fiscal years 2005 - 2007. The settlements with the IRS and the Commonwealth of Massachusetts did not impact our net financial position, results of operations or cash flows. Furthermore, the settlements resulted in the resolution of tax contingencies associated with these tax years which had impacted the effective rate by decreasing tax expense in the first and second quarters by $66.7 million. This amount was offset by a reversal of the related tax indemnification asset which was recorded in selling, general and administrative expenses. The accrual of federal, state and local taxes for the thirty-nine week period ended December 1, 2012 included adjustments to the valuation allowance of $18.1 million.

We recognize 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.


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Over the next 12 months, we believe that it is reasonably possible that the amount of unrecognized tax positions including interest and penalties could decrease tax liabilities by approximately $32.8 million which would impact the effective tax rate if our tax positions are sustained upon audit or the controlling statute of limitations expires. The primary driver of the decrease is contingent upon the statute of limitations expiring. The corresponding indemnification asset will reverse concurrently in selling, general and administrative expenses.

We evaluate our deferred tax assets on a regular basis to determine if a valuation allowance against the net deferred tax assets is required. A cumulative loss in recent years is significant negative evidence in considering whether deferred tax assets are realizable. Based on the negative evidence, we are precluded from relying on projections of future taxable income to support the recognition of deferred tax assets. The ultimate realization of deferred tax assets is dependent upon the existence of sufficient taxable income generated in the carryforward periods.

Liquidity and Capital Resources

General

We have two primary sources of liquidity: (i) cash provided by operating activities and (ii) borrowings under the revolving credit facility of our senior secured credit facility. Our principal uses of cash are to provide working capital for operations, to service our obligations to pay interest and principal on debt and to fund capital expenditures. Total liquidity as of November 30, 2013 was $1,128.3 million.

Credit Facility

Our senior secured credit facility consists of a $1.795 billion revolving credit facility and a $1.155 billion Tranche 6 Term Loan. Borrowings under the revolving credit facility bear interest at a rate per annum between LIBOR plus 2.25% and LIBOR plus 2.75%, if we choose to make LIBOR borrowings, or between Citibank's base rate plus 1.25% and Citibank's base rate plus 1.75% in each case based upon the amount of revolver availability as defined in the senior secured credit facility. We are required to pay fees between 0.375% and 0.50% per annum on the daily unused amount of the revolver, depending on the amount of revolver availability. Amounts drawn under the revolver become due and payable on February 21, 2018.

Our ability to borrow under the revolver is based upon a specified borrowing base consisting of accounts receivable, inventory and prescription files. At November 30, 2013, we had $590.0 million of borrowings outstanding under the revolver and had letters of credit outstanding against the revolver of $87.9 million, which resulted in additional borrowing capacity of $1,117.1 million.

The credit facility also includes our $1.155 billion senior secured term loan (the "Tranche 6 Term Loan"). The Tranche 6 Term Loan matures on February 21, 2020 and currently bears interest at a rate per annum equal to LIBOR plus 3.00% with a LIBOR floor of 1.00%, if we choose to make LIBOR borrowings, or at Citibank's base rate plus 2.00%. We must make mandatory prepayments of the Tranche 6 Term Loan with the proceeds of certain asset dispositions and casualty events (subject to certain limitations), and with the proceeds of certain issuances of debt (subject to certain exceptions). If at any time there is a shortfall in our borrowing base under our senior secured credit facility, prepayment of the Tranche 6 Term Loan may also be required.

The senior secured credit facility restricts us and the subsidiary guarantors from accumulating cash on hand in excess of $200.0 million at any time when revolving loans are outstanding (not including cash located in our store deposit accounts, cash necessary to cover our current liabilities and certain other exceptions) and from accumulating cash on hand with revolver borrowings in excess of $100.0 million over three consecutive business days. The senior secured credit facility also states that if


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at any time (other than following the exercise of remedies or acceleration of any senior obligations or second priority debt and receipt of a triggering notice by the senior collateral agent from a representative of the senior obligations or the second priority debt) either (a) an event of default exists under our senior secured credit facility or (b) the sum of revolver availability under our senior secured credit facility and certain amounts held on deposit with the senior collateral agent in a concentration account is less than $100.0 million for three consecutive business days (a "cash sweep period"), the funds in our deposit accounts will be swept to a concentration account with the senior collateral agent and will be applied first to repay outstanding revolving loans under the senior secured credit facility, and then held as collateral for the senior obligations until such cash sweep period is rescinded pursuant to the terms of our senior secured credit facility.

The senior secured credit facility allows us to have outstanding, at any time, up to $1.5 billion in secured second priority debt and unsecured debt in addition to borrowings under the senior secured credit facility and existing indebtedness, provided that not in excess of $750.0 million of such secured second priority debt and unsecured debt shall mature or require scheduled payments of principal prior to May 21, 2020. The senior secured credit facility allows us to incur an unlimited amount of unsecured debt with a maturity beyond May 21, 2020; however, certain of our other outstanding indebtedness limits the amount of unsecured debt that can be incurred if certain interest coverage levels are not met at the time of incurrence of said debt or other exemptions are not available. The senior secured credit facility also contains certain restrictions on the amount of secured first priority debt we are able to incur. The senior secured facility also allows, so long as the senior secured credit facility is not in default and we maintain availability on the revolving credit facility of more than $100.0 million, for the voluntary repurchase of any debt and the mandatory repurchase of our 8.5% convertible notes due 2015.

Our senior secured credit facility contains covenants which place restrictions on the incurrence of debt beyond the restrictions described above, the payment of dividends, sale of assets, mergers and acquisitions and the granting of liens. Our credit facility also has one financial covenant, which is the maintenance of a fixed charge coverage ratio. The covenant requires that, if availability on the revolving credit facility is less than $150.0 million, we maintain a minimum fixed charge coverage ratio of 1.00 to 1.00. As of November 30, 2013, availability under the revolving credit facility was in excess of $150.0 million and, therefore, the financial covenant was not applicable.

The senior secured credit facility provides for customary events of default including nonpayment, misrepresentation, breach of covenants and bankruptcy. It is also an event of default if we fail to make any required payment on debt having a principal amount in excess of $50.0 million or any event occurs that enables, or which with the giving of notice or the lapse of time would enable, the holder of such debt to accelerate the maturity or require the repurchase of such debt. The mandatory repurchase of the 8.5% convertible notes due 2015 is excluded from this event of default.

On February 21, 2013, we entered into a second priority secured term loan facility, which includes a $470.0 million 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 we choose to make LIBOR borrowings, or at Citibank's base rate plus 3.75%.

On June 21, 2013, we entered into a new second priority secured term loan facility, which includes a $500.0 million 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 we choose to make LIBOR borrowings, or at Citibank's base rate plus 2.875%.

The second priority secured term loan facilities and the indentures that govern our secured and guaranteed unsecured notes contain restrictions on the amount of additional secured and unsecured


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debt that can be incurred by us. As of November 30, 2013, the amount of additional secured debt that could be incurred under the most restrictive covenant of the second priority secured term loan facilities and these indentures was approximately $1.185 billion (which amount does not include the ability to enter into certain sale and leaseback transactions). However, we currently cannot incur any additional secured debt assuming a fully drawn revolver and the outstanding letters of credit. The ability to issue additional unsecured debt under these indentures is generally governed by an interest coverage ratio test. As of November 30, 2013, we had the ability to issue additional unsecured debt under the second lien credit facility and other indentures.

Other Transactions

In June 2013, $419.2 million aggregate principal amount of the outstanding 7.5% senior secured notes due 2017 were tendered and repurchased by us. In July 2013, we redeemed the remaining 7.5% notes for $85.2 million which included the call premium and interest to the redemption date. The tender offer for, and redemption of, the 7.5% notes were funded using the proceeds from the Tranche 2 Term Loan, borrowings under our revolving credit facility and available cash.

On July 2, 2013, we issued $810.0 million of our 6.75% senior notes due 2021. Our obligations under the notes are fully and unconditionally guaranteed, jointly and severally, on an unsubordinated basis, by all of our subsidiaries that guarantee our obligations under our senior secured credit facility, our second priority secured term loan facilities and our outstanding 8.00% senior secured notes due 2020, 10.25% senior secured notes due 2019 and 9.25% senior notes due 2020. We used the net proceeds of the 6.75% notes, borrowings under our revolving credit facility and available cash to repurchase and repay all of our outstanding $810.0 million aggregate principal of 9.5% senior notes due 2017.

In July 2013, $739.6 million aggregate principal amount of the outstanding 9.5% notes were tendered and repurchased by us. In August 2013, we redeemed the remaining 9.5% notes for $73.4 million, which included call premium and interest to the redemption date.

In connection with these refinancing transactions, we recorded a loss on debt retirement, including tender and call premium and interest, unamortized debt issue costs and unamortized discount of $62.2 million during the second quarter of fiscal 2014.

On September 26, 2013, we agreed to exchange eight shares of 7% Series G Convertible Preferred Stock (the "Series G preferred stock") and 1,876,013 shares of 6% Series H Convertible Preferred Stock (the "Series H preferred . . .

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