| RITE AID CORP Item 1A Risk Factors Factors Affecting our Future Prospects Set forth below is a description of certain risk factors which we believe may be relevant to an understanding of us and our business |
| Securityholders are cautioned that these and other factors may affect future performance and cause actual results to differ from those which may, from time to time, be anticipated |
| ” Risks Related to Our Financial Condition We are highly leveraged |
| Our substantial indebtedness could limit cash flow available for our operations and could adversely affect our ability to service debt or obtain additional financing if necessary |
| We had, as of March 4, 2006, dlra3dtta1 billion of outstanding indebtedness and stockholders’ equity of dlra1cmam606dtta9 million |
| We also had additional borrowing capacity under our revolving credit facility of dlra1cmam100dtta3 million at that time, net of outstanding letters of credit of dlra115dtta7 million |
| Our debt obligations adversely affect our operations in a number of ways and while we believe we have adequate sources of liquidity to meet our anticipated requirements for working capital, debt service and capital expenditures through fiscal year 2007, there can be no assurance that our cash flow from operations will be sufficient to service our debt, which may require us to borrow additional funds for that purpose, restructure or otherwise refinance our debt |
| Our high level of indebtedness will continue to restrict our operations |
| Among other things, our indebtedness will: · limit our ability to obtain additional financing; · limit our flexibility in planning for, or reacting to, changes in the markets in which we compete; · place us at a competitive disadvantage relative to our competitors with less indebtedness; · render us more vulnerable to general adverse economic, regulatory and industry conditions; and · require us to dedicate a substantial portion of our cash flow to service our debt |
| Our ability to make payments on our debt depends upon our ability to substantially improve our operating performance, which is subject to general economic and competitive conditions and to financial, business and other factors, many of which we cannot control |
| If our cash flow from our operating activities is insufficient, we may take certain actions, including delaying or reducing capital or other expenditures, attempting to restructure or refinance our debt, selling assets or operations or seeking additional equity capital |
| We may be unable to take any of these actions on satisfactory terms or in a timely manner |
| Further, any of these actions may not be sufficient to allow us to service our debt obligations or may have an adverse impact on our business |
| Our existing debt agreements limit our ability to take certain of these actions |
| Our failure to earn enough to pay our debts or to successfully undertake any of these actions could have a material adverse effect on us |
| Borrowings under our senior secured credit facility and expenses related to the sale of our accounts receivable under our receivables securitization agreements are based upon variable rates of interest, which could result in higher expense in the event of increases in interest rates |
| Approximately dlra534 million of our outstanding indebtedness as of March 4, 2006 bears an interest rate that varies depending upon LIBOR If we borrow additional amounts under our senior credit facility, the interest rate on those borrowings will also vary depending upon LIBOR Further, we pay ongoing 11 ______________________________________________________________________ program fees under our receivables securitization agreements that vary depending upon LIBOR If LIBOR rises, the interest rates on outstanding debt and the program fees under our receivables securitization program will increase |
| Therefore an increase in LIBOR would increase our interest payment obligations under these outstanding loans, increase our receivables securitization program fee payments and have a negative effect on our cash flow and financial condition |
| We currently do not maintain any hedging contracts that would limit our exposure to variable rates of interest |
| The covenants in our outstanding indebtedness impose restrictions that may limit our operating and financial flexibility |
| The covenants in the instruments that govern our outstanding indebtedness limit our ability to: · incur liens and debt; · pay dividends; · make redemptions and repurchases of capital stock; · make loans and investments; · prepay, redeem or repurchase debt; · engage in mergers, consolidations, assets dispositions, sale-leaseback transactions and affiliate transactions; · change our business; · amend some of our debt and other material agreements; · issue and sell capital stock of subsidiaries; · restrict distributions from subsidiaries; and · grant negative pledges to other creditors |
| In addition, if we have less than dlra100dtta0 million available under our revolving credit facility, we will be subject to certain financial covenant ratios |
| If we are unable to meet the terms of the financial covenants or if we breach any of these covenants, a default could result under one or more of these agreements |
| A default, if not waived by our lenders, could result in the acceleration of our outstanding indebtedness and cause our debt to become immediately due and payable |
| If acceleration occurs, we would not be able to repay our debt and it is unlikely that we would be able to borrow sufficient additional funds to refinance such debt |
| Even if new financing is made available to us, it may not be available on terms acceptable to us |
| If we obtain modifications of our agreements, or are required to obtain waivers of defaults, we may incur significant fees and transaction costs |
| Risks Related to Our Operations We need to continue to improve our operations in order to improve our financial condition, but our operations will not improve if we cannot continue to effectively implement our business strategy or if our strategy is negatively affected by general economic conditions |
| We have not yet achieved the sales productivity level of our major competitors |
| We believe that improving the sales of existing stores is important to improving profitability and operating cash flow |
| If we are not successful in implementing our strategy, or if our strategy is not effective, we may not be able to improve our operations |
| In addition, any adverse change in general economic conditions or major industries can adversely affect drug benefit plans and reduce our pharmacy sales or can adversely affect 12 ______________________________________________________________________ consumer buying practices and reduce our sales of front-end products, and cause a decrease in our profitability |
| Failure to continue to improve operations or a decline in major industries or general economic conditions would adversely affect our results of operations, financial condition and cash flows and our ability to make principal or interest payments on our debt |
| Our new store and store relocation development program requires entering construction and development commitments and occasionally purchasing land that will not be utilized for several years which may limit our financial flexibility |
| We will enter into significant construction and development commitments as part of our new store and store relocation development program |
| Also, we will occasionally make capital expenditures to acquire land that may not be used for several years |
| Even if there are significant negative economic or competitive developments in our industry, financial condition or the regions where we have made these commitments, we are obligated to fulfill these commitments |
| Further, if we subsequently dispose of the property that we acquire, we may receive less than our purchase price or the net book value of such property, which may result in financial loss |
| We are dependent on our management team, and the loss of their services could have a material adverse effect on our business and the results of our operations or financial condition |
| The success of our business is materially dependent upon the continued services of our executive management team |
| The loss of key personnel could have a material adverse effect on the results of our operations, financial condition or cash flows |
| Additionally, we cannot assure you that we will be able to attract or retain other skilled personnel in the future |
| We are substantially dependent on a single supplier of pharmaceutical products to sell products to us on satisfactory terms |
| A disruption in this relationship may have a negative effect on our results of operations, financial condition and cash flow |
| We obtain approximately 94prca of the dollar value of our prescription drugs from a single supplier, McKesson, pursuant to a contract that runs through March 2009 |
| Pharmacy sales represented approximately 63dtta2prca of our total sales during fiscal 2006, and, therefore, our relationship with McKesson is important to us |
| Any significant disruptions in our relationship with McKesson would make it difficult for us to continue to operate our business until we executed a replacement strategy |
| There can be no assurance that we would be able to find a replacement supplier on a timely basis or that such supplier would be able to fulfill our demands on similar terms, which would have a material adverse effect on our results of operations, financial condition and cash flows |
| Risks Related to Our Industry The markets in which we operate are very competitive and further increases in competition could adversely affect us |
| We face intense competition with local, regional and national companies, including other drugstore chains, independently owned drugstores, supermarkets, mass merchandisers, discount stores, dollar stores and mail order pharmacies |
| Our industry also faces growing competition from companies who import drugs directly from other countries, such as Canada |
| We may not be able to effectively compete against them because our existing or potential competitors may have financial and other resources that are superior to ours |
| In addition, we may be at a competitive disadvantage because we are more highly leveraged than our competitors |
| The ability of our stores to achieve profitability depends on their ability to achieve a critical mass of customers |
| We believe that the continued consolidation of the drugstore industry will further increase competitive pressures in the industry |
| As competition increases, a significant increase in general pricing pressures could occur, which would require us to increase our sales volume and to sell 13 ______________________________________________________________________ higher margin products and services in order to remain competitive |
| We cannot assure you that we will be able to continue effectively to compete in our markets or increase our sales volume in response to further increased competition |
| Drug benefit plan sponsors and third party payors could change their plan eligibility criteria and further encourage or require the use of mail-order prescriptions which could decrease our sales and reduce our margins and have a material adverse effect on our business |
| An adverse trend for drugstore retailing has been initiatives to contain rising healthcare costs leading to the rapid growth in mail-order prescription processors |
| These prescription distribution methods have grown in market share relative to drugstores as a result of the rapid rise in drug costs experienced in recent years and are predicted to continue to rise |
| Mail-order prescription distribution methods are perceived by employers and insurers as being less costly than traditional distribution methods and are being encouraged, and, in some cases, required, by third party pharmacy benefit managers, employers and unions that administer benefits |
| As a result, some labor unions and employers are requiring, and others may encourage or require, that their members or employees obtain medications from mail-order pharmacies which offer drug prescriptions at prices lower than we are able to offer |
| Another adverse trend for drugstore retailing has been for drug benefit plan sponsors and third party payors to change their plan eligibility requirements resulting in fewer beneficiaries covered and a reduction in the number of prescriptions allowed |
| Mail-order prescription distribution and drug benefit plan eligibility changes have negatively affected sales for traditional chain drug retailers, including us, in the last few years and we expect such negative effect to continue in the future |
| There can be no assurance that our efforts to offset the effects of mail order and eligibility changes will be successful |
| The availability of pharmacy drugs is subject to governmental regulations |
| The continued conversion of various prescription drugs to over-the-counter medications may reduce our pharmacy sales and customers may seek to purchase such medications at non-pharmacy stores |
| Also, if the rate at which new prescription drugs become available slows or if new prescription drugs that are introduced into the market fail to achieve popularity, our pharmacy sales may be adversely affected |
| The withdrawal of certain drugs from the market or concerns about the safety or effectiveness of certain drugs or negative publicity surrounding certain categories of drugs may also have a negative effect on our pharmacy sales or may cause shifts in our pharmacy or front-end product mix |
| For example, growth in late 2004 and 2005 was slowed by the negative publicity surrounding certain arthritis medications and other high-volume drugs, which adversely affected pharmacy sales |
| Changes in third party reimbursement levels for prescription drugs could reduce our margins and have a material adverse effect on our business |
| Sales of prescription drugs, as a percentage of sales, and the percentage of prescription sales reimbursed by third parties, have been increasing and we expect them to continue to increase |
| In fiscal 2006, sales of prescription drugs represented 63dtta2prca of our sales and 93dtta9prca of all of the prescription drugs that we sold were with third party payors |
| During fiscal 2006, the top five third-party payors accounted for approximately 31dtta0prca of our total sales, the largest of which represented 8dtta9prca of our total sales |
| In fiscal 2006, approximately 11dtta4prca of our revenues were from state sponsored Medicaid agencies, the largest of which was less than 3prca of our total sales |
| Beginning January 2006, a significant amount of our Medicaid related prescriptions moved to coverage under the new Medicare Part D plans |
| After considering this shift in payor, we expect Medicaid related sales to represent approximately 8prca of total sales in fiscal 2007 |
| Any significant loss of third-party payor business could have a material adverse effect on our business and results of operations |
| 14 ______________________________________________________________________ Third party payors could reduce the levels at which they will reimburse us for the prescription drugs that we provide to their members |
| Furthermore, the Medicare Part D program, which went into effect January 1, 2006, has reimbursement levels that are lower than the previous level of reimbursement |
| There have been a number of recent proposals and enactments by the Federal government and various states to reduce Medicaid reimbursement levels in response to budget problems, some of which propose to reduce reimbursement levels in the applicable states significantly, and we expect other similar proposals in the future |
| If third party payors reduce their reimbursement levels or if Medicare or state Medicaid programs cover prescription drugs at lower reimbursement levels, our margins on these sales would be reduced, and the profitability of our business and our results of operations, financial condition or cash flows could be adversely affected |
| We are subject to governmental regulations, procedures and requirements; our noncompliance or a significant regulatory change could adversely affect our business, the results of our operations or our financial condition |
| Our pharmacy business is subject to federal, state and local government laws and regulation |
| These include local registrations of pharmacies in the states where our pharmacies are located, applicable Medicare and Medicaid regulations and prohibitions against paid referrals of patients |
| Failure to properly adhere to these and other applicable regulations could result in the imposition of civil and criminal penalties including suspension of payments from government programs; loss of required government certifications; loss of authorizations to participate in or exclusion from government reimbursement programs, such as the Medicare and Medicaid programs; loss of licenses; significant fines or monetary penalties for anti-kickback law violations, submission of false claims or other failures to meet reimbursement program requirements and could adversely affect the continued operation of our business |
| Our pharmacy business is subject to the patient privacy and other obligations including corporate, pharmacy and associate responsibility, imposed by the Health Insurance Portability and Accountability Act |
| As a covered entity, we are required to implement privacy standards, train our associates on the permitted use and disclosures of protected health information, provide a notice of privacy practice to our pharmacy customers and permit pharmacy health customers to access and amend their records and receive an accounting of disclosures of protected health information |
| Failure to properly adhere to these requirements could result in the imposition of civil as well as criminal penalties |
| Federal and state reform programs, such as healthcare reform and enforcement initiatives of federal and state governments may also affect our pharmacy business |
| These initiatives include: · proposals designed to significantly reduce spending on Medicare, Medicaid and other government programs; · changes in programs providing for reimbursement for the cost of prescription drugs by third party plans; · the Medicare Modernization Act; · increased scrutiny of, and litigation relating to, prescription drug manufacturers’ pricing and marketing pactices; and · regulatory changes relating to the approval process for prescription drugs |
| These initiatives could lead to the enactment of, or changes to, federal regulations and state regulations that could adversely impact our prescription drug sales and, accordingly, our results of operations, financial condition or cash flows |
| It is uncertain at this time what additional healthcare reform initiatives, if any, will be implemented, or whether there will be other changes in the administration of governmental healthcare programs or interpretations of governmental policies or other changes affecting 15 ______________________________________________________________________ the healthcare system |
| Future healthcare or budget legislation or other changes, including those referenced above, may materially adversely impact our pharmacy sales |
| Certain risks are inherent in providing pharmacy services; our insurance may not be adequate to cover any claims against us |
| Pharmacies are exposed to risks inherent in the packaging and distribution of pharmaceuticals and other healthcare products, such as with respect to improper filling of prescriptions, labeling of prescriptions, adequacy of warnings and unintentional distribution of counterfeit drugs |
| In addition, federal and state laws that require our pharmacists to offer counseling, without additional charge, to their customers about medication, dosage, delivery systems, common side effects and other information the pharmacists deem significant can impact our business |
| Our pharmacists may also have a duty to warn customers regarding any potential negative effects of a prescription drug if the warning could reduce or negate these effects |
| Although we maintain professional liability and errors and omissions liability insurance, from time to time, claims result in the payment of significant amounts, some portions of which are not funded by insurance |
| We cannot assure you that the coverage limits under our insurance programs will be adequate to protect us against future claims, or that we will be able to maintain this insurance on acceptable terms in the future |
| Our results of operations, financial condition or cash flows may be adversely affected if in the future our insurance coverage proves to be inadequate or unavailable or there is an increase in liability for which we self-insure or we suffer reputational harm as a result of an error or omission |
| We will not be able to compete effectively if we are unable to attract, hire and retain qualified pharmacists |
| There is a nationwide shortage of qualified pharmacists |
| However, we may not be able to attract, hire and retain enough qualified pharmacists |
| This could adversely affect our operations |
| We may be subject to significant liability should the consumption of any of our products cause injury, illness or death |
| Products that we sell could become subject to contamination, product tampering, mislabeling or other damage requiring us to recall our private label products |
| In addition, errors in the dispensing and packaging of pharmaceuticals could lead to serious injury or death |
| Product liability claims may be asserted against us with respect to any of the products or pharmaceuticals we sell and we may be obligated to recall our private brand products |
| A product liability judgment against us or a product recall could have a material, adverse effect on our business, financial condition or results of operations |