Basis of Presentation

9 Months Ended

Nov. 30, 2019

Basis of Presentation

Basis of Presentation

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X and therefore do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete annual financial statements. The accompanying financial information reflects all adjustments which are of a recurring nature and, in the opinion of management, are necessary for a fair presentation of the results for the interim periods. The results of operations for the thirteen and thirty-nine week periods ended November 30, 2019 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 2019 10-K.

In addition to the significant accounting policies discussed in the Company’s Fiscal 2019 10-K, the Company has added the following significant accounting policies as a result of its adoption of ASU No. 2016-02 and 2018-11, Leases, (Topic 842) on March 3, 2019 under the alternative transition method as permissible under ASU 2018-11 (please see Note 12. Leases, for additional details).

Recently Adopted Accounting Pronouncements

In February 2016, the FASB issued ASU No. 2016-02, Leases, (Topic 842) (“ASU-2016-02” or the “Lease Standard”), 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). This ASU requires organizations that lease assets—referred to as “lessees”—to recognize on the balance sheet a right of use asset (“ROU asset”) and a lease liability for the obligations created by those leases. ASU No. 2016-02 is effective for fiscal years and interim periods within those years beginning January 1, 2019.

During July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements. The ASU provides administrative relief by allowing entities to implement the Lease Standard using an alternative transition method. Effectively, the alternative transition method permits adoption of the Lease Standard through an adjustment to its opening balance sheet for the period of adoption, with the cumulative effect accounted for as an adjustment to retained earnings, without restating prior periods.

The Company adopted the Lease Standard on March 3, 2019 under the alternative transition method as permissible under ASU 2018-11, and applied the Lease Standard to all leases through a cumulative-effect adjustment to beginning accumulated deficit. As a result, comparative financial information has not been restated and continues to be reported under the accounting standards in effect for those periods. The Company elected the package of practical expedients permitted under the transition guidance within the Lease Standard, which includes, among other things, the ability to carry forward the existing lease classification. On March 3, 2019, the Company recorded a liability for operating leases of $3,295,327, a ROU asset for such leases of $3,026,976 and recorded an after-tax transition adjustment to increase accumulated deficit by $56,776. The Lease Standard had a material impact on the unaudited condensed consolidated balance sheet, but did not have a material impact on the unaudited condensed consolidated statement of operations or the unaudited condensed consolidated statement of cash flows.

As permitted under the practical expedient concerning assessment of lease portfolio, the Company chose not to reassess its lease portfolio, and consequently, all existing leases that were classified as operating leases in accordance with Topic 840, continue to be classified as operating leases, and all existing leases that were classified as capital leases under Topic 840 continue to be classified as finance leases.

The Company performed an evaluation of ROU asset for impairment on transition. Stores that had previously been impaired and continued to fail the recoverability test as of March 2, 2019 were evaluated. Any store ROU asset with a carrying amount in excess of fair value was written down to the fair value. Fair value of those ROU assets was determined based on a study of market rents for similar active/operating retails sites. The result of this impairment assessment was a $81,745 write-down of the ROU assets on transition to accumulated deficit. In addition, the Company recognized $24,969 of deferred gains as a reduction to accumulated deficit upon transition related to prior sale-leaseback transactions along with other minor adjustments.

As of March 2, 2019, the Company had $124,046 in closed store and lease exit liabilities under Topic 420 (“Topic 420 Liabilities”). Under transition to Topic 842, existing Topic 420 liabilities were eliminated by recording a reduction to the ROU asset balance. However, in certain cases the Company had larger existing Topic 420 liabilities than the ROU asset balances. This excess amount of $9,333 continues to be recorded as a liability and will reduce lease expense over the remaining lease term of the affected stores. In addition, upon transition, the Company reclassified deferred rent, including unamortized tenant income allowances, prepaid rent, and favorable and unfavorable lease balances resulting from prior acquisition accounting to the ROU asset.

The following is a discussion of the Company’s lease policy under the new lease accounting standard:

The Company determines if an arrangement contains a lease at the inception of a contract. Operating lease right-of-use assets represent the Company’s right to use an underlying asset for the lease term and operating lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Operating lease right-of-use assets and operating lease liabilities are recognized at the commencement date based on the present value of the remaining future minimum lease payments. As the interest rate implicit in the Company’s leases is not readily determinable, the Company utilizes its incremental borrowing rate, determined by class of underlying asset, to discount the lease payments. The incremental borrowing rate is determined using a portfolio approach based on the rate of interest that we would pay to borrow an amount equal to the lease payments on a collateralized basis over a similar term. We use quoted interest rates obtained from financial institutions in an input to derive our incremental borrowing rate as the discount rate for the lease. The ROU asset is equal to the operating lease liability plus lease payments made before commencement, less lease incentives received from the landlord.

The Company’s real estate leases typically contain options that permit lease extensions for additional periods of up to five years each. For real estate leases, generally, the renewal periods are not included within the lease term and the associated payments are not included in the measurement of the ROU asset and operating lease liability as the options to extend are not considered reasonably certain to occur at lease commencement. The Company reevaluates each lease on a regular basis to consider the economic and strategic incentives of exercising the renewal options and will include all reasonably certain options in the measurement of our lease term. Generally, the renewal option periods are not included within the lease term and the associated payments are not included in the measurement of the operating lease right-of-use asset and the operating lease liability until the renewals are i) evaluated and ii) determined to be exercised. The Company has an insignificant amount of non-real estate leases however, renewal options are not included in the lease term for non-

real estate leases because they are not considered reasonably certain of being exercised at lease commencement. The Company rarely executes leases less than 12 months. On transition, the Company did include in its ROU asset balance leases with less than 12 months remaining.

For real estate leases, the Company accounts for lease components and non-lease components as a single lease component. Certain real estate leases require additional payments based on sales volume, as well as reimbursement for real estate taxes, common area maintenance and insurance, which are expensed as incurred as variable lease costs. Other real estate leases contain one fixed lease payment that includes real estate taxes, common area maintenance and insurance. These fixed payments are considered part of the lease payment and included in the operating lease right-of-use assets and operating lease liabilities.

Impact of the Lease Standard on Financial Statement Line Items

As a result of applying the alternative transition method to adopt the Lease Standard, the following adjustments were made to accounts on the unaudited condensed consolidated balance sheet as of March 3, 2019:

	Impact of change in accounting policy
(in thousands)	As reported				As adjusted
	March 2, 2019		Adjustments		March 3, 2019
ASSETS
Current assets:
Cash and cash equivalents	$	144,353	$	—	$	144,353
Accounts receivable, net		1,788,712		—		1,788,712
Inventories, net		1,871,941		—		1,871,941
Prepaid expenses and other current assets		179,132		(51,448)		127,684
Current assets held for sale		117,581		43,697		161,278
Total current assets		4,101,719		(7,751)		4,093,968
Property, plant and equipment, net		1,308,514		—		1,308,514
Operating lease right-of-use asset		—		3,026,976		3,026,976
Goodwill		1,108,136		—		1,108,136
Other intangibles, net		448,706		(29,632)		419,074
Deferred tax assets		409,084		—		409,084
Other assets		215,208		(1,086)		214,122
Total assets	$	7,591,367	$	2,988,507	$	10,579,874
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt and lease financing obligations	$	16,111	$	—	$	16,111
Accounts payable		1,618,585		—		1,618,585
Accrued salaries, wages and other current liabilities		808,439		(56,553)		751,886
Current portion of operating lease liabilities		—		457,305		457,305
Current liabilities held for sale		—		45,167		45,167
Total current liabilities		2,443,135		445,919		2,889,054
Long-term debt, less current maturities		3,454,585		—		3,454,585
Long-term operating lease liabilities		—		2,838,022		2,838,022
Lease financing obligations, less current maturities		24,064		—		24,064
Other noncurrent liabilities		482,893		(238,658)		244,235
Total liabilities		6,404,677		3,045,283		9,449,960
Commitments and contingencies		—		—		—
Stockholders’ equity:
Common stock, par value $1 per share; 75,000 shares authorized; shares issued and outstanding 54,016		54,016		—		54,016
Additional paid-in capital		5,876,977		—		5,876,977
Accumulated deficit		(4,713,244)		(56,776)		(4,770,020)
Accumulated other comprehensive loss		(31,059)		—		(31,059)
Total stockholders’ equity		1,186,690		(56,776)		1,129,914
Total liabilities and stockholders’ equity	$	7,591,367	$	2,988,507	$	10,579,874

See Note 12 for additional information.

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers (Topic 606). ASU No. 2014-09 outlines a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers and

supersedes most current revenue recognition guidance, including industry-specific guidance. In March 2016, the FASB issued ASU No. 2016-08, Principal Versus Agent Considerations (Reporting Revenue Gross Versus Net), which amends the principal-versus-agent implementation guidance and in April 2016, the FASB issued ASU No. 2016-10, Identifying Performance Obligations and Licensing, which amends the guidance in those areas in the new revenue recognition standard. These ASUs, collectively the “new revenue standard“, are effective for annual reporting periods (including interim reporting periods within those periods) beginning January 1, 2018.

The Company adopted the new revenue standard as of March 4, 2018 using the modified retrospective method and applying the new standard to all contracts with customers. In connection with the adoption of the new revenue standard, the Company identified one difference in its Retail Pharmacy segment related to the timing of revenue recognition for third party prescription revenues, which was historically recognized at the time the prescription was filled. Upon adoption of ASU No. 2014-09, this revenue is recognized at the time the customer takes possession of the merchandise. In connection with its March 4, 2018 adoption of the new revenue standard on a modified retrospective basis, the Company recorded a reduction to accounts receivable of $57,897, a reduction to deferred tax assets of $1,771, an increase to inventory of $51,121, and a corresponding increase to accumulated deficit of $8,547 within its Retail Pharmacy segment.

In addition, the Company identified revenues under one specific rebate administration program under which the Company's Pharmacy Services segment was determined to be the principal and historically recognized revenues and cost of revenues on a gross basis of approximately $123,500 during fiscal 2018. Upon adoption of the new revenue standard, the Company is now recording revenue from this program on a net basis.

The following is a discussion of the Company's revenue recognition policies by segment under the new revenue recognition accounting standard:

Revenue Recognition

Retail Pharmacy Segment

For front-end sales, the Retail Pharmacy segment recognizes revenues upon the transfer of control of the goods to the customer. The Company satisfies its performance obligation at the point of sale for front-end transactions. The Retail Pharmacy segment front-end revenue is measured based on the amount of fixed consideration that it expects to receive, net of an allowance for estimated future returns. Return activity is immaterial to revenues and results of operations in all periods presented.

For pharmacy sales, the Retail Pharmacy segment recognizes revenue upon the transfer of control of the goods to the customer. The Company satisfies its performance obligation, upon pickup by the customer, which is when the customer takes title to the product. Each prescription claim represents an individual arrangement with the customer and is a performance obligation, separate and distinct from other prescription claims. The Company’s revenue is measured based on the amount of fixed consideration that we expect to receive, reduced by refunds owed to the third party payor for pricing guarantees and performance against defined value-based service and performance metrics. The inputs to these estimates are not highly subjective or volatile. The effect of adjustments between estimated and actual amounts have not been material to the Company’s results of operations or financial position. Prescriptions are generally not returnable.

The Retail Pharmacy segment offers a chain-wide loyalty card program titled wellness +. Individual customers are able to become members of the wellness + program. Members participating in the wellness + loyalty card program earn points on a calendar year basis for eligible front-end merchandise purchases and qualifying prescription purchases. One point is awarded for each dollar spent towards front-end merchandise and 25 points are awarded for each qualifying prescription.

Effective January 1, 2020, members reach specific wellness + tiers based on points accumulated during the six calendar month periods between January 1^st and June 30^th, and July 1^st through December 31^st, which entitles such customers to certain future discounts and other benefits upon reaching that tier. For example, any customer that reaches 500 points during the six calendar month period between January 1^st and June 30^th achieves the “Gold” tier, enabling him or her to receive a 20% discount on qualifying purchases of front-end merchandise for the remaining portion of that six calendar month period and for the following six calendar months. There is also a similar “Silver” level with a lower threshold and benefit level. Prior to January 1, 2020, the wellness + tiers were based on points accumulated for a full calendar year, and entitled such customers to wellness + benefits for the remainder of that calendar year and also the next calendar year.

Points earned pursuant to the wellness+ program represent a performance obligation and the Company allocates revenue between the merchandise purchased and the wellness + points based on the relative stand-alone selling price of each performance obligation. The relative value of the wellness + points is initially deferred as a contract liability (included in other current and noncurrent liabilities). As members receive discounted front-end merchandise or when the benefit period expires, the Retail Pharmacy segment recognizes an allocable portion of the deferred contract liability into revenue. The Retail Pharmacy segment had accrued contract liabilities of $67,517 as of November 30, 2019, of which $62,339 is included in other current liabilities and $5,178 is included in noncurrent liabilities. The Retail Pharmacy segment had accrued contract liabilities of $63,720 as of March 2, 2019, of which $51,042 is included in other current liabilities and $12,678 is included in noncurrent liabilities.

Pharmacy Services Segment

The Pharmacy Services segment sells prescription drugs indirectly through its retail pharmacy network and directly through its mail service dispensing pharmacy. The Pharmacy Services segment recognizes revenue from prescription drugs sold by (i) its mail service dispensing pharmacy and (ii) under retail pharmacy network contracts where it is the principal at the contract prices negotiated with its clients, primarily employers, insurance companies, unions, government employee groups, health plans, Managed Medicaid plans, Medicare plans, and other sponsors of health benefit plans, and individuals throughout the United States. Revenues include: (i) the portion of the price the client pays directly to the Pharmacy Services segment, net of any volume-related or other discounts paid back to the client (see “Drug Discounts” below), (ii) the price paid to the Pharmacy Services segment by client plan members for mail order prescriptions (“Mail Co-Payments”), (iii) client plan member copayments made directly to the retail pharmacy network and (iv) administrative fees. Revenue is recognized when the Pharmacy Services segment meets its performance obligations relative to each transaction type. The following revenue recognition policies have been established for the Pharmacy Services segment:

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

segment’s online claims processing system. At this point the Company has performed all of its performance obligations.

● Revenues generated from prescription drugs sold by the Pharmacy Services segment’s mail service dispensing pharmacy are recognized when the prescription is shipped. At the time of shipment, the Pharmacy Services segment has performed all of its performance obligations under its client contracts, as control of and title to the product has passed to the client plan members. The Pharmacy Services segment does not experience a significant level of returns or reshipments.

● Revenues generated from administrative fees based on membership or claims volume are recognized monthly based on the terms within the individual contracts, either a monthly member based fee, or a claims volume based fee.

In the majority of its contracts, the Pharmacy Services segment is the principal because its client contracts give clients the right to obtain access to its pharmacy contracts under which the Pharmacy Services segment directs its pharmacy network to provide the services (drug dispensing, consultation, etc.) and goods (prescription drugs) to the clients’ members at its negotiated pricing. The Pharmacy Services segment’s obligations under its client contracts are separate and distinct from its obligations to the third party pharmacies included in its retail pharmacy network contracts. In the majority of these contracts, the Pharmacy Services segment is contractually required to pay the third party pharmacies in its retail pharmacy network for products sold after payment is received from its clients. The Pharmacy Services segment has control over these transactions until the prescription is transferred to the member and, thus, that it is acting as a principal. As such, the Pharmacy Services segment records the total prescription price contracted with clients in revenues.

Amounts paid to pharmacies and amounts charged to clients are exclusive of the applicable co-payment under Pharmacy Services segment contracts. Retail pharmacy co-payments, which we instruct retail pharmacies to collect from members, are included in our revenues and our cost of revenues.

For contracts under which the Pharmacy Services segment acts as an agent or does not control the prescription drugs prior to transfer to the client, no revenue is recognized, except the administrative fee.

Drug Discounts—The Pharmacy Services segment deducts from its revenues that are generated from prescription drugs sold by third party pharmacies any rebates, inclusive of discounts and fees, earned by its clients based on utilization levels and other factors as negotiated with the prescription drug manufacturers or suppliers. Rebates are paid to clients in accordance with the terms of client contracts.

Medicare Part D—The Pharmacy Services segment, through its Envision Insurance Company ("EIC") subsidiary, participates in the federal government’s Medicare Part D program as a Prescription Drug Plan (“PDP”). Please refer to Note 8, Medicare Part D.

Disaggregation of Revenue

The following tables disaggregate the Company’s revenue by major source in each segment for the thirteen and thirty-nine week periods ended November 30, 2019:

	Thirteen Week Period Ended		Thirty-Nine Week Period Ended
In thousands	November 30, 2019		November 30, 2019
Retail Pharmacy segment:
Pharmacy sales	$	2,623,832	$	7,761,052
Front-end sales		1,250,946		3,767,796
Other revenue		35,168		94,010
Total Retail Pharmacy segment		3,909,946		11,622,858
Pharmacy Services segment		1,613,109		4,758,470
Intersegment elimination		(60,757)		(180,177)
Total revenue	$	5,462,298	$	16,201,151

Recently Issued Accounting Pronouncements Not Yet Adopted

In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments, which adds to U.S. GAAP an impairment model (known as the current expected credit loss ("CECL") model), that is based on expected losses rather than incurred losses. Under ASU 2016-13, an entity will recognize, as an allowance, its estimate of lifetime expected credit losses, which the FASB believes will result in more timely recognition of such losses. ASU 2016-13 impacts non-banks as most non-banks have financial instruments or other assets (e.g. trade, contract and lease receivables, financial guarantees, loans and loan commitments and held-to-maturity debt securities). The Company is evaluating the effect of adopting ASU 2016-13, but does not expect the adoption to have a material impact on the Company’s financial position, results of operations and cash flows.

Reclassification of the Statements of Cash Flows presentation

During fiscal 2019, the Company expanded its disclosure on its Statements of Cash Flows to include changes in other assets separate from changes in other liabilities, which had historically been combined. Prior period amounts have been reclassified to conform to the current period presentation.

Recasting of per-share amounts

The Company implemented a reverse stock split of the Company’s common stock at a reverse stock split ratio of 1-for-20. The Company’s common stock began trading on a split-adjusted basis on the NYSE at the market open on April 22, 2019. Accordingly, all share and per-share amounts for the prior period has been recasted to reflect the reverse stock split.