e Consider the 8 125 notes due 2010 Assume that Rite Aid issued these notes on May 1, 2003 and that the company pays interest on the last day of April each year i According to a press release issued by Rite Aid at the time of the issuance, the proceeds of the notes issue were 98 688 of the face value of the notes Prepare the journal entry that Rite Aid must have made when these notes were issued ii At what effective annual rate of interest were these notes issued iii Assume that Rite Aid uses the effective interest rate method to account for this debt Use the guidance for the table that follows to prepare an amortization schedule for these notes Use the last column to verify that each year's interest expense uses the same interest rate even though the expense changes Interest Interest Bond Discount Net Book Effective Date Payment Expense Amortization Value of Debt Interest Rate May 1, 2003 $ 355,276 80 May 1, 2004 $ 29,250 May 1, 2005 May 1 2006 May 1, 2007 May 1, 2008 May 1, 2009 May 1, 2010 o May 1, 2003 Net Book Value is the initial proceeds of the bond issuance, net of costs The face value of this debt is $360,000, the discount is $4,723 20 the coupon rate is 8 125 and the effective rate (including fees) is 8 3803 Interest Payment is the face value of the bond times the coupon rate of the bond Interest Expense equals opening book value of the debt times the effective interest rate The difference between the interest payment and interest expense is the amortization of the bond discount This is equivalent to saying that interest expense equals the interest paid plus the amortization of the bond discount O Amortizing the discount increases the net book value of the bond Prepare the journal entry that Rite Aid must have recorded February 28, 2004 to accrue interest expense on these notes Based on your answer to part iv what is the book value of the notes at February 28, 2004 Your answer to part v will be different from the amount that Rite Aid reported because the company used the straight line method to amortize the discount on these notes instead of the effective interest rate method Use the guidance that follows to complete the following table using the straight line method to amortize the bond discount Use the last column in the table to record the interest rate each year Under this method, does Rite Aid report the same interest rate on these notes each year iv V vi vii Compare the year by year difference in interest expense derived from each method What pattern do you observe Is the difference material in any year 191 RITE AID CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except per share amounts) February 28, 2004 March 1 2003 365,321 ASSETS Current assets Cash and cash equivalents Accounts receivable, net Inventories, net Prepaid expenses and other current assets Total current assets Property, plant and equipment, net Goodwill Other intangibles, net Other assets Total assets $ 334,755 670,004 2,223,171 150,067 3,377,997 1,883,808 684,535 176,672 123,667 $ 6,246,679 $ 575,518 2,195,030 108,018 3,243,887 1,868,579 684,535 199,768 136,746 $ 6,133,515 $ 23,976 758,290 701,484 1,483,750 246,000 3,451,352 170,338 885,975 6,237,415 $ 103,715 755,284 707,999 1,566,998 244,500 3,345,365 169,048 900,270 6,226,181 LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities Short term debt and current maturities of convertible notes, long term debt and lease financing obligations Accounts payable Accrued salaries, wages and other current liabilities Total current liabilities Convertible notes Long term debt, less current maturitics Lease financing obligations, less current maturities Other noncurrent liabilities Total liabilities Commitments and contingencies Redeemable preferred stock Stockholders' equity (deficit) Preferred stock, par value $1 per share liquidation value $100 per share 20,000 shares authorized shares issued 4,178 and 3,937 Common stock, par value $1 per share 1,000,000 shares authorized shares issued and outstanding 516,496 and 515,115 Additional paid in capital Accumulated deficit Stock based and deferred compensation Accumulated other comprehensive loss Total stockholders' equity (deficit) Total liabilities and stockholders' equity (deficit) 19,663 417,803 393,705 516,496 3,133,277 (4 035,433) 515,115 3,119,619 (4,118,119) 5,369 (28,018) (112,329 $ 6,133,515 (22,879) 9,264 $ 6,246,679 The accompanying notes are an integral part of these consolidated financial statements 41 192 RITE AID CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts) Year Ended March 1, 2003 $15,791,278 February 28, 2004 $16,600,449 March 2 2007 $15,166,170 12,568,405 3,594,405 12,035,537 3,471,573 4,806 11,697,912 3,422,383 (15,891) 29,821 21,007 Revenues Costs and expenses Cost of goods sold, including occupancy costs Selling, general and administrative expenses Stock based compensation expense (benefit) Goodwill amortization Store closing and impairment charges Interest expense Interest rate swap contracts Loss (gain) on debt modifications and retirements, net Share of loss from equity investments Loss (gain) on sale of assets and investments, net 22,466 313,498 135,328 330,020 278 251,617 396,064 41,894 35,315 (13,628) 2,023 16,565,933 34,516 (48,795) 83,311 (18,620) 15,945,294 (154,016) (41,940) $ (112,076) 221,054 12,092 (42,536 16,005,596 (839,426) (11,745) (827,681) Income (loss) before income taxes Income tax bencfil Net income (loss) Computation of income (loss) applicable to common stockholders Net income (loss) Accretion of redeemable preferred stock Preferred stock beneficial conversion Cumulative preferred stock dividends Net income (loss) applicable to common stockholders Basic and diluted income (loss) per share Net income (loss) per share $ (112,076) (102) 83,311 (102) (625) (24 098) 58,486 $ (827,681) (104) (6,406) (27 530) $ (861,721) (32,201) $ (144,379) $ 0 11 (0 28) $ (1 82) The accompanying notes are an integral part of these consolidated financial statements 42 193 RITE AID CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) February 28, 2004 Year Ended March 1 21N13 March 2 2002 $ 83,311 $(112,076) $ (827,681) 264 288 22,466 285,334 135,328 278 (18,620) 4,806 349,840 251,617 41,894 (42,536) (15,891) 2,023 29,821 35,315 (13,628) 221,054 Changes in (94,486) (48,014) (61,209) (17,162) 11,162 227,515 14 803 40,555 24,018 (62,314) 6,899 305,383 (69,004) 112,649 (14,635) (5,004) 14,040 16,343 Operating Activities Net income (loss) Adjustments to reconcile to net cash provided by operations Depreciation and amortization Store closings and impairment loss Interest rate swap contracts Loss (gain) on sale of assets and investments, net Stock based compensation expense (benefit) Loss (gain) on debt modifications and retirements, nel in operating assets and liabilities Accounts receivable Inventories Income taxes receivable payable Accounts payable Other assets and liabilities, net Net cash provided by operating activities Investing Activities Expenditures for property, plant and equipment Intangible assets acquired Proceeds from the sale of Advance PCS securities and notes Proceeds from dispositions Net cash (used in provided by investing activities Financing activities Net proceeds from the issuance of long term debt Net change in bank credit facilities Proceeds from the issuance of bonds Principal payments on long term debt Change in zero balance cash account Net proceeds from the issuance of common stock Deferred financing costs paid Net cash used in financing activities Increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year (250,668) (16,705) (104,507) (11,647) (175,183) (12,200) 25,223 484,214 45 700 43,940 (242,150) (72,214) 342,531 1,378,462 (222,500) 502,950 (264,324) (4 613) 3,541 (30,985) (15,931) (30,566) 365,321 $ 334,755 (5 962) 300,000 (477 466) (12,936) 279 (15,818) (211,903) 21 266 344,055 $365,321 392,500 (2,277,431) (48,131) 530,589 (83,098) (107,109) 251,765 92 290 344,055 The accompanying notes are an integral part of these consolidated financial statements 45 194 RITE AID CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) For the Years Ended February 28, 2004, March 1, 2003 and March 2, 2002 (In thousands, except per sbare amounts) 10 Indebtedness and Credit Agreements Following is a summary of indebtedness and lease financing obligations at February 28, 2004 and March 1, 2003 February 28, 2004 March 1, 2003 $1,150,000 1,372,500 Secured Debt Senior secured credit facility due April 2008 Senior secured credit facility due March 2005 12 5 senior secured notes due September 2006 ($142,025 and $152,025 face value less unamortized discount of $4,158 and 6,143) 8 125 senior secured notes due May 2010 ($360,000 face value less unamortized discount of $4,168) 9 5 senior secured notes due February 2011 Other 137,867 145,882 355,832 300,000 5,125 1,948,824 183 169 300,000 6,540 1,824,922 176,186 198,000 38,047 58,125 198,000 75,895 Lease Financing Obligations Unsecured Debt 6 0 dealer remarketable securities due October 2003 7 625 senior notes due April 2005 6 0 fixed rate senior notes due December 2005 4 75 convertible potes due December 2006 ($250,000 face value less unamortized discount of $4,000 and $5,500) 7 125 notes due January 2007 11 25 senior notes due July 2008 son 6 125 fixed rate senior notes due December 2008 0 125 9 25 senior notes due Junc 2013 ($150,000 face value less unamortized discount of $2,221) 6 875 senior debentures due August 2013 7 7 notes due February 2027 6 875 fixed rate senior notes due December 2028 246,000 210,074 150,000 150,000 244,500 335,000 150 000 150,000 147,779 184,773 295 000 140,000 1,759,673 200,000 300,000 150,000 1,861,520 3,891,666 3,862,628 (23 976) (103,715) Total debt Short term debt and current maturities of convertible notes, long term debt and lease financing obligations Long term debt and lease financing obligations, less current maturities $3,867,690 $3,758,913 60 195 RITE AID CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) For the Years Ended February 28, 2004, March 1, 2003 and March 2, 2002 (In thousands, except per share amounts) 2004 Transactions New Credit Facility On May 28, 2003, the Company replaced its senior secured credit facility with a new senior secured credit facility The new facility consists of a $1,150,000 term loan and a $700,000 revolving credit facility, and will mature on April 30, 2008 The proceeds of the loans made on the closing of the new credit facility were, among other things, used repay the outstanding amounts under the old facility and to purchase the land and buildings at the Company's Perryman, MD and Lancaster, CA distribution centers, which had previously been leased through a synthetic lease arrangement On August 4, 2003, the Company amended and restated the senior secured credit facility, which reduced the interest rate on term loan borrowings under the scnior secured credit facility by 50 basis points Borrowings under the new facility currently bear interest either at LIBOR plus 3 00 for the term loan and 3 50 for the revolving credit facility, if the Company chooses to make LIBOR borrowings, or at Citibank's base rate plus 2 00 for the term of the loan and 2 50 for the revolving credit facility The Company is required to pay fees of 0 50 per annum on the daily unused amount of the revolving facility Amortization payments of $2,875 related to the term loan will begin on May 31, 2004, and continue on a quarterly basis until February 28, 2008, with a final payment of $1,104,000 due April 30, 2008 Substantially all of Rite Aid Corporation's wholly owned subsidiaries guarantee the obligations under the new senior secured credit facility The subsidiary guarantees are secured by a first priority lien on, among other things, the inventory, accounts receivable and prescription files of the subsidiary guarantors Rite Aid Corporation is a holding company with no direct operations and is dependent upon dividends, distributions and other payments from its subsidiaries to service payments under the new senior secured credit facility Rite Aid Corporation's direct obligations under the new senior secured credit facility are unsecured, The new senior secured credit facility allows for the issuance of up to $150,000 in additional term loans or additional revolver availability The Company may request the additional loans at any time prior to the maturity of the senior secured credit facility, provided that the Company is not in default of any terms of the facility, nor is in violation of any financial covenants The new senior secured credit facility allows the Company to have outstanding, at any time, up to $1,000,000 in secured debt in addition to the senior secured credit facility At February 28, 2004, the remaining additional permitted secured debt under the new senior credit facility is $197,975 The Company has the ability to incur an unlimited amount of unsecured debt, if the terms of such unsecured indebtedness comply with certain terms set forth in the credit agreement and subject to the Company's compliance with certain financial covenants If the Company issues unsecured debt that does not meet the credit agreement restrictions, it reduces the amount of available permitted secured debt The new senior secured credit facility also allows for the repurchase of any debt with a maturity prior to 2008, and for a limited amount of debt with a maturity after April 30, 2008, based upon outstanding borrowings under the revolving credit facility and available cash at the time of the repurchase The new senior secured credit facility contains customary covenants, which place restrictions on incurrence of debt, the payment of dividends, mergers, liens and sale and leaseback transactions The new senior secured credit facility also requires meet various financial ratios and limits capital expenditures For the twelve months ending February 26, 2005, the covenants require us to maintain a maximum leverage ratio of 6 05 1 Subsequent to February 26, 2005, the ratio gradually decreases to 3 8 1 for the twelve months ending March 1, 2008 We also maintain a minimum interest coverage ratio of 2 05 1 for the twelve months ending February 26, 2005 Subsequent to February 26, 2005, the ratio gradually increases to 3 25 1 for the twelve months ending March 1, 2008 In addition, we must maintain a minimum fixed charge ratio of 1 10 1 for the twelve months ending February 26, April 30, 61 196 RITE AID CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) For the Years Ended February 28, 2004, March 1, 2003 and March 2, 2002 (In thousands, except per share amounts) 2005 Subsequent to February 26, 2005, the ratio gradually increases to 1 25 1 for the twelve months ending March 1, 2008 Capital expenditures are limited to $386,085 for the fiscal year ending February 26, 2005, with the allowable amount increasing in subsequent years The Company was in compliance with the covenants of the new senior secured credit facility and its other debt instruments as of February 28, 2004 With continuing improvements in operating performance, the Company anticipates that it will remain in compliance with its debt covenants However, variations in operating performance and unanticipated developments may adversely affect the Company's ability to remain in compliance with the applicable debt covenants The new 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 any event occurs that enables, or which with the giving of notice or the lapse of time would enable, the holder of the Company's debt to accelerate the maturity of debt having a principal amount in excess of $25,000 The Company's ability to borrow under the senior secured credit facility is based on a specified borrowing base consisting of eligible accounts receivable, inventory and prescription files At February 28, 2004, the term loan was fully drawn and the Company had no outstanding draws on the revolving credit facility At February 28, 2004, the Company had additional borrowing capacity of $584,804, net of outstanding letters of credit of $115,196 As a result of the placement of the new senior secured credit facility, the Company recorded a loss on debt modification in fiscal 2004 of $43,197 (which included the write off of previously deferred debt issue costs of $35,120) On October 1, 2003, the Company paid, at maturity, remaining outstanding balance on the 6 0 dealer remarketable securities In May 2003, the Company issued $150,000 aggregate principal amount of 9 25 senior notes due 2013 These notes are unsecured and effectively subordinate to the Company's secured debt The indenture governing the 9 25 senior notes contains customary covenant provisions that amount other things, include limitations on the Company's ability to pay dividends, make investments or other restricted payments, incur debt, grant liens, sell assets and enter into sale lease back transactions In April 2003, the Company issued $360,000 aggregate principal amount of 8 125 senior secured notes due 2010 The notes are unsecured, unsubordinated obligations to Rite Aid Corporation and rank equally in right of payment with all other unsecured, unsubordinated indebtedness The Company's obligations under the notes are guaranteed, subject to certain limitations, by subsidiaries that guarantee the obligations under our new senior secured credit facility The guarantees are secured, subject to the permitted liens, by shared second priority liens, with the holders of the Company's 12 5 senior notes and the Company's 9 5 senior secured notes, granted by subsidiary guarantors on all of their assets that secure the obligations under the new senior secured credit facility, subject to certain exceptions The indenture governing the Company's 8 125 senior secured notes contains customary covenant provisions that, among other things, include limitations on our ability to pay dividends, make investments or other restricted payments, incur debt, grant liens, sell assets and enter into sales lease back transactions 62 197 RITE AID CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) For the Years Ended February 28, 2004, March 1, 2003 and March 2, 2002 (In thousands, except per share amounts) During fiscal 2004 the Company repurchased the following securities Debt Repurchased 6 0 fixed rate senior notes due 2005 7 125 notes due 2007 6 875 senior debentures due 2013 7 7 notes due 2027 6 875 fixed rate senior notes due 2028 12 5 senior secured notes due 2006 Total Principal Amount Repurchased $ 37,848 124,926 15,227 5,000 10,000 10,000 $203,001 Amount Paid $ 36,853 120,216 13,144 4,219 7,975 11,275 $193,682 (Gain) luss $ (865) (4,314) (1,981) (715) (1,895) 1,888 $(7,882) 2003 Transactions Senior Secured Notes The Company issued $300,000 of 9 5 senior secured notes due 2011 in February 2003 The notes were unsecured, unsubordinated obligations of the Company and rank equally in right of payment with all of the Company's other unsecured, unsubordinated indebtedness The Company's obligations under the notes are guaranteed, subject to certain limitations, by subsidiaries that guarantee the obligations under the senior secured credit facility The guarantees are secured, subject to the permitted liens, by shared second priority liens with the holders of the 12 5 senior notes and the 8 125 senior secured notes, granted by subsidiary guarantors on all assets that secure the Company's obligations under the senior secured credit facility, subject to certain limitations Proceeds from these notes were used to redeem all the $149,500 of the Company's senior secured (shareholders) notes due 2006 as well as to fund other debt repurchases and general corporate purposes Repurchase of Debt The Company repurchased $25,425 of its 6 0 dealer remarketable securities due 2003, $118,605 of its 6 0 notes due 2005, and $15,000 of its 7 125 notes due 2007 during fiscal 2003 In addition to the debt repurchases noted above, the Company retired $150,500 of its 5 25 convertible subordinated notes at maturity in September 2002, and made quarterly mandatory repayments on the senior secured credit facility term loan totaling $27,500 during fiscal 2003 These fiscal 2003 transactions resulted in a gain of $13,628 on debt retirements and modifications 2002 Refinancing and Other Transactions On June 27, 2001, the Company completed a major financial restructuring that extended the maturity dates of the majority of its debt to 2005 or beyond, provided additional equity and converted a portion of its debt to equity These transactions are described below Senior Secured Credit Facility The Company entered into a new $1,900,000 senior secured credit facility This facility was replaced by the new senior secured credit facility discussed above High Yield Notes The Company issued $150,000 of 11 25 senior notes due July 2008 These notes are unsecured and are effectively subordinate to the secured debt of the Company, Debt for Debt Exchange The Company cxchanged $152,025 of its cxisting 10 5 senior secured notes due 2002 for an equal amount of 12 5 senior notes due September 2006 In addition, holders of these notes received warrants to purchase 3,000 shares of Company common stock at $6 00 share On June 29, 2001, the warrant holders exercised these warrants, on a cashless basis, and as a result approximately 982 shares of common stock were issued 63 198 During the third quarter of fiscal 2004, the Company recorded a non recurring income tax benefit, driven by the approval by the Congressional Joint Committee on Taxation on the conclusions of the Internal Revenue Service examination of the Company's federal tax returns for the fiscal years 1996 through 2000 During the first quarter of fiscal 2004, the Company recorded a loss on debt modification of $43,197 related to the placement of its new senior secured credit facility During the fourth quarter of fiscal 2003, the Company incurred $78,277 in store closing and impairment charges The Company also recorded a $27,700 million credit related to the elimination of several liabilities for former executives and a $19,502 million reduction of its LIFO reserve related to a lower level of inflation than originally estimated During the second quarter of fiscal 2003, the Company incurred $58,223 in store closing and impairment charges In the first quarter of fiscal 2003, the company incurred a charge of $20,000 to reserve for probable loss related to the U S Attorney's investigation of former management's business practices The Company also recorded a tax benefit of $44,011 related to a tax law change that increased the carryback period from two years to five for certain net operating losses 20 Financial Instruments The carrying amounts and fair values of financial instruments at February 28, 2004 and March 1, 2003 are listed as follows 2004 2003 Carrying Fair Carrying Fuir Amount Value Amount Value Variable rate indebtedness $1,150,000 $1,150,000 $1,372,500 $1,372,500 Fixed rate indebtedness $2,558,497 $2 640,995 $2,313,942 $2,027,603 Cash, trade receivables and trade payables are carried at market value, which approximates their fair values due to the short term maturity of these instruments The following methods and assumptions were used in estimating fair value disclosures for financial instruments LIBOR based borrowings under credit facilities The carrying amounts for LIBOR based borrowings under the credit facilities, term loans and term notes approximate their fair values due to the short term nature of the obligations and the variable interest rates Long term indebtedness The fair values of long term indebtedness is estimated based on the quoted market prices of the financial instruments If quoted market prices were not available, the Company estimated the fair value based on the quoted market price of a financial instrument with similar characteristics 79 e Consider the 8 125 notes due 2010 Assume that Rite Aid issued these notes on May 1, 2003 and that the company pays interest on the last day of April each year i According to a press release issued by Rite Aid at the time of the issuance, the proceeds of the notes issue were 98 688 of the face value of the notes Prepare the journal entry that Rite Aid must have made when these notes were issued ii At what effective annual rate of interest were these notes issued iii Assume that Rite Aid uses the effective interest rate method to account for this debt Use the guidance for the table that follows to prepare an amortization schedule for these notes Use the last column to verify that each year's interest expense uses the same interest rate even though the expense changes Interest Interest Bond Discount Net Book Effective Date Payment Expense Amortization Value of Debt Interest Rate May 1, 2003 $ 355,276 80 May 1, 2004 $ 29,250 May 1, 2005 May 1 2006 May 1, 2007 May 1, 2008 May 1, 2009 May 1, 2010 o May 1, 2003 Net Book Value is the initial proceeds of the bond issuance, net of costs The face value of this debt is $360,000, the discount is $4,723 20 the coupon rate is 8 125 and the effective rate (including fees) is 8 3803 Interest Payment is the face value of the bond times the coupon rate of the bond Interest Expense equals opening book value of the debt times the effective interest rate The difference between the interest payment and interest expense is the amortization of the bond discount This is equivalent to saying that interest expense equals the interest paid plus the amortization of the bond discount O Amortizing the discount increases the net book value of the bond Prepare the journal entry that Rite Aid must have recorded February 28, 2004 to accrue interest expense on these notes Based on your answer to part iv what is the book value of the notes at February 28, 2004 Your answer to part v will be different from the amount that Rite Aid reported because the company used the straight line method to amortize the discount on these notes instead of the effective interest rate method Use the guidance that follows to complete the following table using the straight line method to amortize the bond discount Use the last column in the table to record the interest rate each year Under this method, does Rite Aid report the same interest rate on these notes each year iv V vi vii Compare the year by year difference in interest expense derived from each method What pattern do you observe Is the difference material in any year 191 RITE AID CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except per share amounts) February 28, 2004 March 1 2003 365,321 ASSETS Current assets Cash and cash equivalents Accounts receivable, net Inventories, net Prepaid expenses and other current assets Total current assets Property, plant and equipment, net Goodwill Other intangibles, net Other assets Total assets $ 334,755 670,004 2,223,171 150,067 3,377,997 1,883,808 684,535 176,672 123,667 $ 6,246,679 $ 575,518 2,195,030 108,018 3,243,887 1,868,579 684,535 199,768 136,746 $ 6,133,515 $ 23,976 758,290 701,484 1,483,750 246,000 3,451,352 170,338 885,975 6,237,415 $ 103,715 755,284 707,999 1,566,998 244,500 3,345,365 169,048 900,270 6,226,181 LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities Short term debt and current maturities of convertible notes, long term debt and lease financing obligations Accounts payable Accrued salaries, wages and other current liabilities Total current liabilities Convertible notes Long term debt, less current maturitics Lease financing obligations, less current maturities Other noncurrent liabilities Total liabilities Commitments and contingencies Redeemable preferred stock Stockholders' equity (deficit) Preferred stock, par value $1 per share liquidation value $100 per share 20,000 shares authorized shares issued 4,178 and 3,937 Common stock, par value $1 per share 1,000,000 shares authorized shares issued and outstanding 516,496 and 515,115 Additional paid in capital Accumulated deficit Stock based and deferred compensation Accumulated other comprehensive loss Total stockholders' equity (deficit) Total liabilities and stockholders' equity (deficit) 19,663 417,803 393,705 516,496 3,133,277 (4 035,433) 515,115 3,119,619 (4,118,119) 5,369 (28,018) (112,329 $ 6,133,515 (22,879) 9,264 $ 6,246,679 The accompanying notes are an integral part of these consolidated financial statements 41 192 RITE AID CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts) Year Ended March 1, 2003 $15,791,278 February 28, 2004 $16,600,449 March 2 2007 $15,166,170 12,568,405 3,594,405 12,035,537 3,471,573 4,806 11,697,912 3,422,383 (15,891) 29,821 21,007 Revenues Costs and expenses Cost of goods sold, including occupancy costs Selling, general and administrative expenses Stock based compensation expense (benefit) Goodwill amortization Store closing and impairment charges Interest expense Interest rate swap contracts Loss (gain) on debt modifications and retirements, net Share of loss from equity investments Loss (gain) on sale of assets and investments, net 22,466 313,498 135,328 330,020 278 251,617 396,064 41,894 35,315 (13,628) 2,023 16,565,933 34,516 (48,795) 83,311 (18,620) 15,945,294 (154,016) (41,940) $ (112,076) 221,054 12,092 (42,536 16,005,596 (839,426) (11,745) (827,681) Income (loss) before income taxes Income tax bencfil Net income (loss) Computation of income (loss) applicable to common stockholders Net income (loss) Accretion of redeemable preferred stock Preferred stock beneficial conversion Cumulative preferred stock dividends Net income (loss) applicable to common stockholders Basic and diluted income (loss) per share Net income (loss) per share $ (112,076) (102) 83,311 (102) (625) (24 098) 58,486 $ (827,681) (104) (6,406) (27 530) $ (861,721) (32,201) $ (144,379) $ 0 11 (0 28) $ (1 82) The accompanying notes are an integral part of these consolidated financial statements 42 193 RITE AID CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) February 28, 2004 Year Ended March 1 21N13 March 2 2002 $ 83,311 $(112,076) $ (827,681) 264 288 22,466 285,334 135,328 278 (18,620) 4,806 349,840 251,617 41,894 (42,536) (15,891) 2,023 29,821 35,315 (13,628) 221,054 Changes in (94,486) (48,014) (61,209) (17,162) 11,162 227,515 14 803 40,555 24,018 (62,314) 6,899 305,383 (69,004) 112,649 (14,635) (5,004) 14,040 16,343 Operating Activities Net income (loss) Adjustments to reconcile to net cash provided by operations Depreciation and amortization Store closings and impairment loss Interest rate swap contracts Loss (gain) on sale of assets and investments, net Stock based compensation expense (benefit) Loss (gain) on debt modifications and retirements, nel in operating assets and liabilities Accounts receivable Inventories Income taxes receivable payable Accounts payable Other assets and liabilities, net Net cash provided by operating activities Investing Activities Expenditures for property, plant and equipment Intangible assets acquired Proceeds from the sale of Advance PCS securities and notes Proceeds from dispositions Net cash (used in provided by investing activities Financing activities Net proceeds from the issuance of long term debt Net change in bank credit facilities Proceeds from the issuance of bonds Principal payments on long term debt Change in zero balance cash account Net proceeds from the issuance of common stock Deferred financing costs paid Net cash used in financing activities Increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year (250,668) (16,705) (104,507) (11,647) (175,183) (12,200) 25,223 484,214 45 700 43,940 (242,150) (72,214) 342,531 1,378,462 (222,500) 502,950 (264,324) (4 613) 3,541 (30,985) (15,931) (30,566) 365,321 $ 334,755 (5 962) 300,000 (477 466) (12,936) 279 (15,818) (211,903) 21 266 344,055 $365,321 392,500 (2,277,431) (48,131) 530,589 (83,098) (107,109) 251,765 92 290 344,055 The accompanying notes are an integral part of these consolidated financial statements 45 194 RITE AID CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) For the Years Ended February 28, 2004, March 1, 2003 and March 2, 2002 (In thousands, except per sbare amounts) 10 Indebtedness and Credit Agreements Following is a summary of indebtedness and lease financing obligations at February 28, 2004 and March 1, 2003 February 28, 2004 March 1, 2003 $1,150,000 1,372,500 Secured Debt Senior secured credit facility due April 2008 Senior secured credit facility due March 2005 12 5 senior secured notes due September 2006 ($142,025 and $152,025 face value less unamortized discount of $4,158 and 6,143) 8 125 senior secured notes due May 2010 ($360,000 face value less unamortized discount of $4,168) 9 5 senior secured notes due February 2011 Other 137,867 145,882 355,832 300,000 5,125 1,948,824 183 169 300,000 6,540 1,824,922 176,186 198,000 38,047 58,125 198,000 75,895 Lease Financing Obligations Unsecured Debt 6 0 dealer remarketable securities due October 2003 7 625 senior notes due April 2005 6 0 fixed rate senior notes due December 2005 4 75 convertible potes due December 2006 ($250,000 face value less unamortized discount of $4,000 and $5,500) 7 125 notes due January 2007 11 25 senior notes due July 2008 son 6 125 fixed rate senior notes due December 2008 0 125 9 25 senior notes due Junc 2013 ($150,000 face value less unamortized discount of $2,221) 6 875 senior debentures due August 2013 7 7 notes due February 2027 6 875 fixed rate senior notes due December 2028 246,000 210,074 150,000 150,000 244,500 335,000 150 000 150,000 147,779 184,773 295 000 140,000 1,759,673 200,000 300,000 150,000 1,861,520 3,891,666 3,862,628 (23 976) (103,715) Total debt Short term debt and current maturities of convertible notes, long term debt and lease financing obligations Long term debt and lease financing obligations, less current maturities $3,867,690 $3,758,913 60 195 RITE AID CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) For the Years Ended February 28, 2004, March 1, 2003 and March 2, 2002 (In thousands, except per share amounts) 2004 Transactions New Credit Facility On May 28, 2003, the Company replaced its senior secured credit facility with a new senior secured credit facility The new facility consists of a $1,150,000 term loan and a $700,000 revolving credit facility, and will mature on April 30, 2008 The proceeds of the loans made on the closing of the new credit facility were, among other things, used repay the outstanding amounts under the old facility and to purchase the land and buildings at the Company's Perryman, MD and Lancaster, CA distribution centers, which had previously been leased through a synthetic lease arrangement On August 4, 2003, the Company amended and restated the senior secured credit facility, which reduced the interest rate on term loan borrowings under the scnior secured credit facility by 50 basis points Borrowings under the new facility currently bear interest either at LIBOR plus 3 00 for the term loan and 3 50 for the revolving credit facility, if the Company chooses to make LIBOR borrowings, or at Citibank's base rate plus 2 00 for the term of the loan and 2 50 for the revolving credit facility The Company is required to pay fees of 0 50 per annum on the daily unused amount of the revolving facility Amortization payments of $2,875 related to the term loan will begin on May 31, 2004, and continue on a quarterly basis until February 28, 2008, with a final payment of $1,104,000 due April 30, 2008 Substantially all of Rite Aid Corporation's wholly owned subsidiaries guarantee the obligations under the new senior secured credit facility The subsidiary guarantees are secured by a first priority lien on, among other things, the inventory, accounts receivable and prescription files of the subsidiary guarantors Rite Aid Corporation is a holding company with no direct operations and is dependent upon dividends, distributions and other payments from its subsidiaries to service payments under the new senior secured credit facility Rite Aid Corporation's direct obligations under the new senior secured credit facility are unsecured, The new senior secured credit facility allows for the issuance of up to $150,000 in additional term loans or additional revolver availability The Company may request the additional loans at any time prior to the maturity of the senior secured credit facility, provided that the Company is not in default of any terms of the facility, nor is in violation of any financial covenants The new senior secured credit facility allows the Company to have outstanding, at any time, up to $1,000,000 in secured debt in addition to the senior secured credit facility At February 28, 2004, the remaining additional permitted secured debt under the new senior credit facility is $197,975 The Company has the ability to incur an unlimited amount of unsecured debt, if the terms of such unsecured indebtedness comply with certain terms set forth in the credit agreement and subject to the Company's compliance with certain financial covenants If the Company issues unsecured debt that does not meet the credit agreement restrictions, it reduces the amount of available permitted secured debt The new senior secured credit facility also allows for the repurchase of any debt with a maturity prior to 2008, and for a limited amount of debt with a maturity after April 30, 2008, based upon outstanding borrowings under the revolving credit facility and available cash at the time of the repurchase The new senior secured credit facility contains customary covenants, which place restrictions on incurrence of debt, the payment of dividends, mergers, liens and sale and leaseback transactions The new senior secured credit facility also requires meet various financial ratios and limits capital expenditures For the twelve months ending February 26, 2005, the covenants require us to maintain a maximum leverage ratio of 6 05 1 Subsequent to February 26, 2005, the ratio gradually decreases to 3 8 1 for the twelve months ending March 1, 2008 We also maintain a minimum interest coverage ratio of 2 05 1 for the twelve months ending February 26, 2005 Subsequent to February 26, 2005, the ratio gradually increases to 3 25 1 for the twelve months ending March 1, 2008 In addition, we must maintain a minimum fixed charge ratio of 1 10 1 for the twelve months ending February 26, April 30, 61 196 RITE AID CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) For the Years Ended February 28, 2004, March 1, 2003 and March 2, 2002 (In thousands, except per share amounts) 2005 Subsequent to February 26, 2005, the ratio gradually increases to 1 25 1 for the twelve months ending March 1, 2008 Capital expenditures are limited to $386,085 for the fiscal year ending February 26, 2005, with the allowable amount increasing in subsequent years The Company was in compliance with the covenants of the new senior secured credit facility and its other debt instruments as of February 28, 2004 With continuing improvements in operating performance, the Company anticipates that it will remain in compliance with its debt covenants However, variations in operating performance and unanticipated developments may adversely affect the Company's ability to remain in compliance with the applicable debt covenants The new 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 any event occurs that enables, or which with the giving of notice or the lapse of time would enable, the holder of the Company's debt to accelerate the maturity of debt having a principal amount in excess of $25,000 The Company's ability to borrow under the senior secured credit facility is based on a specified borrowing base consisting of eligible accounts receivable, inventory and prescription files At February 28, 2004, the term loan was fully drawn and the Company had no outstanding draws on the revolving credit facility At February 28, 2004, the Company had additional borrowing capacity of $584,804, net of outstanding letters of credit of $115,196 As a result of the placement of the new senior secured credit facility, the Company recorded a loss on debt modification in fiscal 2004 of $43,197 (which included the write off of previously deferred debt issue costs of $35,120) On October 1, 2003, the Company paid, at maturity, remaining outstanding balance on the 6 0 dealer remarketable securities In May 2003, the Company issued $150,000 aggregate principal amount of 9 25 senior notes due 2013 These notes are unsecured and effectively subordinate to the Company's secured debt The indenture governing the 9 25 senior notes contains customary covenant provisions that amount other things, include limitations on the Company's ability to pay dividends, make investments or other restricted payments, incur debt, grant liens, sell assets and enter into sale lease back transactions In April 2003, the Company issued $360,000 aggregate principal amount of 8 125 senior secured notes due 2010 The notes are unsecured, unsubordinated obligations to Rite Aid Corporation and rank equally in right of payment with all other unsecured, unsubordinated indebtedness The Company's obligations under the notes are guaranteed, subject to certain limitations, by subsidiaries that guarantee the obligations under our new senior secured credit facility The guarantees are secured, subject to the permitted liens, by shared second priority liens, with the holders of the Company's 12 5 senior notes and the Company's 9 5 senior secured notes, granted by subsidiary guarantors on all of their assets that secure the obligations under the new senior secured credit facility, subject to certain exceptions The indenture governing the Company's 8 125 senior secured notes contains customary covenant provisions that, among other things, include limitations on our ability to pay dividends, make investments or other restricted payments, incur debt, grant liens, sell assets and enter into sales lease back transactions 62 197 RITE AID CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) For the Years Ended February 28, 2004, March 1, 2003 and March 2, 2002 (In thousands, except per share amounts) During fiscal 2004 the Company repurchased the following securities Debt Repurchased 6 0 fixed rate senior notes due 2005 7 125 notes due 2007 6 875 senior debentures due 2013 7 7 notes due 2027 6 875 fixed rate senior notes due 2028 12 5 senior secured notes due 2006 Total Principal Amount Repurchased $ 37,848 124,926 15,227 5,000 10,000 10,000 $203,001 Amount Paid $ 36,853 120,216 13,144 4,219 7,975 11,275 $193,682 (Gain) luss $ (865) (4,314) (1,981) (715) (1,895) 1,888 $(7,882) 2003 Transactions Senior Secured Notes The Company issued $300,000 of 9 5 senior secured notes due 2011 in February 2003 The notes were unsecured, unsubordinated obligations of the Company and rank equally in right of payment with all of the Company's other unsecured, unsubordinated indebtedness The Company's obligations under the notes are guaranteed, subject to certain limitations, by subsidiaries that guarantee the obligations under the senior secured credit facility The guarantees are secured, subject to the permitted liens, by shared second priority liens with the holders of the 12 5 senior notes and the 8 125 senior secured notes, granted by subsidiary guarantors on all assets that secure the Company's obligations under the senior secured credit facility, subject to certain limitations Proceeds from these notes were used to redeem all the $149,500 of the Company's senior secured (shareholders) notes due 2006 as well as to fund other debt repurchases and general corporate purposes Repurchase of Debt The Company repurchased $25,425 of its 6 0 dealer remarketable securities due 2003, $118,605 of its 6 0 notes due 2005, and $15,000 of its 7 125 notes due 2007 during fiscal 2003 In addition to the debt repurchases noted above, the Company retired $150,500 of its 5 25 convertible subordinated notes at maturity in September 2002, and made quarterly mandatory repayments on the senior secured credit facility term loan totaling $27,500 during fiscal 2003 These fiscal 2003 transactions resulted in a gain of $13,628 on debt retirements and modifications 2002 Refinancing and Other Transactions On June 27, 2001, the Company completed a major financial restructuring that extended the maturity dates of the majority of its debt to 2005 or beyond, provided additional equity and converted a portion of its debt to equity These transactions are described below Senior Secured Credit Facility The Company entered into a new $1,900,000 senior secured credit facility This facility was replaced by the new senior secured credit facility discussed above High Yield Notes The Company issued $150,000 of 11 25 senior notes due July 2008 These notes are unsecured and are effectively subordinate to the secured debt of the Company, Debt for Debt Exchange The Company cxchanged $152,025 of its cxisting 10 5 senior secured notes due 2002 for an equal amount of 12 5 senior notes due September 2006 In addition, holders of these notes received warrants to purchase 3,000 shares of Company common stock at $6 00 share On June 29, 2001, the warrant holders exercised these warrants, on a cashless basis, and as a result approximately 982 shares of common stock were issued 63 198 During the third quarter of fiscal 2004, the Company recorded a non recurring income tax benefit, driven by the approval by the Congressional Joint Committee on Taxation on the conclusions of the Internal Revenue Service examination of the Company's federal tax returns for the fiscal years 1996 through 2000 During the first quarter of fiscal 2004, the Company recorded a loss on debt modification of $43,197 related to the placement of its new senior secured credit facility During the fourth quarter of fiscal 2003, the Company incurred $78,277 in store closing and impairment charges The Company also recorded a $27,700 million credit related to the elimination of several liabilities for former executives and a $19,502 million reduction of its LIFO reserve related to a lower level of inflation than originally estimated During the second quarter of fiscal 2003, the Company incurred $58,223 in store closing and impairment charges In the first quarter of fiscal 2003, the company incurred a charge of $20,000 to reserve for probable loss related to the U S Attorney's investigation of former management's business practices The Company also recorded a tax benefit of $44,011 related to a tax law change that increased the carryback period from two years to five for certain net operating losses 20 Financial Instruments The carrying amounts and fair values of financial instruments at February 28, 2004 and March 1, 2003 are listed as follows 2004 2003 Carrying Fair Carrying Fuir Amount Value Amount Value Variable rate indebtedness $1,150,000 $1,150,000 $1,372,500 $1,372,500 Fixed rate indebtedness $2,558,497 $2 640,995 $2,313,942 $2,027,603 Cash, trade receivables and trade payables are carried at market value, which approximates their fair values due to the short term maturity of these instruments The following methods and assumptions were used in estimating fair value disclosures for financial instruments LIBOR based borrowings under credit facilities The carrying amounts for LIBOR based borrowings under the credit facilities, term loans and term notes approximate their fair values due to the short term nature of the obligations and the variable interest rates Long term indebtedness The fair values of long term indebtedness is estimated based on the quoted market prices of the financial instruments If quoted market prices were not available, the Company estimated the fair value based on the quoted market price of a financial instrument with similar characteristics 79

Question

e  Consider the 8 125  notes due 2010  Assume that Rite Aid issued these notes on May 1, 2003 and that the company pays interest on the last day of April each year  i  According to a press release issued by Rite Aid at the time of the issuance, the proceeds of the notes issue were 98 688  of the face value of the notes  Prepare the journal entry that Rite Aid must have made when these notes were issued  ii  At what effective annual rate of interest were these notes issued  iii  Assume that Rite Aid uses the effective interest rate method to account for this debt  Use the guidance for the table that follows to prepare an amortization schedule for these notes  Use the last column to verify that each year's interest expense uses the same interest rate even though the expense changes  Interest Interest Bond Discount Net Book Effective Date Payment Expense Amortization Value of Debt Interest Rate May 1, 2003 $ 355,276 80 May 1, 2004 $ 29,250 May 1, 2005 May 1 2006 May 1, 2007 May 1, 2008 May 1, 2009 May 1, 2010     o May 1, 2003 Net Book Value is the initial proceeds of the bond issuance, net of costs  The face value of this debt is $360,000, the discount is $4,723 20  the coupon rate is 8 125  and the effective rate (including fees) is 8 3803   Interest Payment is the face value of the bond times the coupon rate of the bond  Interest Expense equals opening book value of the debt times the effective interest rate  The difference between the interest payment and interest expense is the amortization of the bond discount  This is equivalent to saying that interest expense equals the interest paid plus the amortization of the bond discount  O Amortizing the discount increases the net book value of the bond  Prepare the journal entry that Rite Aid must have recorded February 28, 2004 to accrue interest expense on these notes  Based on your answer to part iv  what is the book value of the notes at February 28, 2004  Your answer to part v  will be different from the amount that Rite Aid reported because the company used the straight line method to amortize the discount on these notes instead of the effective interest rate method  Use the guidance that follows to complete the following table using the straight line method to amortize the bond discount  Use the last column in the table to record the interest rate each year  Under this method, does Rite Aid report the same interest rate on these notes each year  iv  V  vi  vii  Compare the year by year difference in interest expense derived from each method  What pattern do you observe  Is the difference material in any year   191  RITE AID CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except per share amounts) February 28, 2004 March 1  2003 365,321 ASSETS Current assets  Cash and cash equivalents Accounts receivable, net Inventories, net         Prepaid expenses and other current assets Total current assets Property, plant and equipment, net Goodwill Other intangibles, net Other assets Total assets $ 334,755 670,004 2,223,171 150,067 3,377,997 1,883,808 684,535 176,672 123,667 $ 6,246,679 $ 575,518 2,195,030 108,018 3,243,887 1,868,579 684,535 199,768 136,746 $ 6,133,515 $ 23,976 758,290 701,484 1,483,750 246,000 3,451,352 170,338 885,975 6,237,415 $ 103,715 755,284 707,999 1,566,998 244,500 3,345,365 169,048 900,270 6,226,181 LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities  Short term debt and current maturities of convertible notes, long term debt and lease financing obligations Accounts payable             Accrued salaries, wages and other current liabilities Total current liabilities Convertible notes Long term debt, less current maturitics Lease financing obligations, less current maturities Other noncurrent liabilities Total liabilities Commitments and contingencies Redeemable preferred stock Stockholders' equity (deficit)  Preferred stock, par value $1 per share  liquidation value $100 per share  20,000 shares authorized  shares issued   4,178 and 3,937 Common stock, par value $1 per share  1,000,000 shares authorized  shares issued and outstanding 516,496 and 515,115 Additional paid in capital     Accumulated deficit Stock based and deferred compensation Accumulated other comprehensive loss Total stockholders' equity (deficit) Total liabilities and stockholders' equity (deficit)  19,663 417,803 393,705 516,496 3,133,277 (4 035,433) 515,115 3,119,619 (4,118,119) 5,369 (28,018) (112,329 $ 6,133,515 (22,879) 9,264 $ 6,246,679 The accompanying notes are an integral part of these consolidated financial statements  41  192  RITE AID CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts) Year Ended March 1, 2003 $15,791,278 February 28, 2004 $16,600,449 March 2 2007 $15,166,170 12,568,405 3,594,405 12,035,537 3,471,573 4,806 11,697,912 3,422,383 (15,891) 29,821 21,007 Revenues  Costs and expenses  Cost of goods sold, including occupancy costs Selling, general and administrative expenses Stock based compensation expense (benefit) Goodwill amortization  Store closing and impairment charges Interest expense   Interest rate swap contracts Loss (gain) on debt modifications and retirements, net   Share of loss from equity investments Loss (gain) on sale of assets and investments, net      22,466 313,498 135,328 330,020 278 251,617 396,064 41,894 35,315 (13,628) 2,023 16,565,933 34,516 (48,795) 83,311 (18,620) 15,945,294 (154,016) (41,940) $ (112,076) 221,054 12,092 (42,536 16,005,596 (839,426) (11,745) (827,681) Income (loss) before income taxes Income tax bencfil    Net income (loss)  Computation of income (loss) applicable to common stockholders  Net income (loss)           Accretion of redeemable preferred stock Preferred stock beneficial conversion Cumulative preferred stock dividends Net income (loss) applicable to common stockholders  Basic and diluted income (loss) per share  Net income (loss) per share  $ (112,076) (102) 83,311 (102) (625) (24 098) 58,486 $ (827,681) (104) (6,406) (27 530) $ (861,721) (32,201) $ (144,379) $ 0 11 (0 28) $ (1 82) The accompanying notes are an integral part of these consolidated financial statements  42  193 RITE AID CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) February 28, 2004 Year Ended March 1 21N13 March 2 2002 $ 83,311 $(112,076) $ (827,681) 264 288 22,466 285,334 135,328 278 (18,620) 4,806 349,840 251,617 41,894 (42,536) (15,891) 2,023 29,821 35,315 (13,628) 221,054 Changes in (94,486) (48,014) (61,209) (17,162) 11,162 227,515 14 803 40,555 24,018 (62,314) 6,899 305,383 (69,004) 112,649 (14,635) (5,004) 14,040 16,343 Operating Activities  Net income (loss)  Adjustments to reconcile to net cash provided by operations  Depreciation and amortization Store closings and impairment loss Interest rate swap contracts         Loss (gain) on sale of assets and investments, net    Stock based compensation expense (benefit) Loss (gain) on debt modifications and retirements, nel     in operating assets and liabilities  Accounts receivable  Inventories  Income taxes receivable payable Accounts payable  Other assets and liabilities, net Net cash provided by operating activities Investing Activities  Expenditures for property, plant and equipment     Intangible assets acquired  Proceeds from the sale of Advance PCS securities and notes    Proceeds from dispositions  Net cash (used in provided by investing activities Financing activities  Net proceeds from the issuance of long term debt Net change in bank credit facilities   Proceeds from the issuance of bonds  Principal payments on long term debt Change in zero balance cash account  Net proceeds from the issuance of common stock   Deferred financing costs paid    Net cash used in financing activities  Increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year (250,668) (16,705) (104,507) (11,647) (175,183) (12,200) 25,223 484,214 45 700 43,940 (242,150) (72,214) 342,531 1,378,462 (222,500) 502,950 (264,324) (4 613) 3,541 (30,985) (15,931) (30,566) 365,321 $ 334,755 (5 962) 300,000 (477 466) (12,936) 279 (15,818) (211,903) 21 266 344,055 $365,321 392,500 (2,277,431) (48,131) 530,589 (83,098) (107,109) 251,765 92 290 344,055 The accompanying notes are an integral part of these consolidated financial statements  45  194  RITE AID CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) For the Years Ended February 28, 2004, March 1, 2003 and March 2, 2002 (In thousands, except per sbare amounts) 10  Indebtedness and Credit Agreements Following is a summary of indebtedness and lease financing obligations at February 28, 2004 and March 1, 2003  February 28, 2004 March 1, 2003 $1,150,000 1,372,500 Secured Debt  Senior secured credit facility due April 2008 Senior secured credit facility due March 2005 12 5  senior secured notes due September 2006 ($142,025 and $152,025 face value less unamortized discount of $4,158 and 6,143)                8 125  senior secured notes due May 2010 ($360,000 face value less unamortized discount of $4,168) 9 5  senior secured notes due February 2011 Other 137,867 145,882 355,832 300,000 5,125 1,948,824 183 169 300,000 6,540 1,824,922 176,186 198,000 38,047 58,125 198,000 75,895 Lease Financing Obligations  Unsecured Debt  6 0  dealer remarketable securities due October 2003 7 625  senior notes due April 2005    6 0  fixed rate senior notes due December 2005 4 75  convertible potes due December 2006 ($250,000 face value less unamortized discount of $4,000 and $5,500) 7 125  notes due January 2007     11 25  senior notes due July 2008  son 6 125  fixed rate senior notes due December 2008  0 125 9 25  senior notes due Junc 2013 ($150,000 face value less unamortized discount of $2,221) 6 875  senior debentures due August 2013 7 7  notes due February 2027            6 875  fixed rate senior notes due December 2028 246,000 210,074 150,000 150,000 244,500 335,000 150 000 150,000 147,779 184,773 295 000 140,000 1,759,673 200,000 300,000 150,000 1,861,520 3,891,666 3,862,628 (23 976) (103,715) Total debt      Short term debt and current maturities of convertible notes, long  term debt and lease financing obligations  Long term debt and lease financing obligations, less current maturities      $3,867,690 $3,758,913 60  195 RITE AID CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) For the Years Ended February 28, 2004, March 1, 2003 and March 2, 2002 (In thousands, except per share amounts) 2004 Transactions New Credit Facility  On May 28, 2003, the Company replaced its senior secured credit facility with a new senior secured credit facility  The new facility consists of a $1,150,000 term loan and a $700,000 revolving credit facility, and will mature on April 30, 2008  The proceeds of the loans made on the closing of the new credit facility were, among other things, used repay the outstanding amounts under the old facility and to purchase the land and buildings at the Company's Perryman, MD and Lancaster, CA distribution centers, which had previously been leased through a synthetic lease arrangement  On August 4, 2003, the Company amended and restated the senior secured credit facility, which reduced the interest rate on term loan borrowings under the scnior secured credit facility by 50 basis points  Borrowings under the new facility currently bear interest either at LIBOR plus 3 00  for the term loan and 3 50  for the revolving credit facility, if the Company chooses to make LIBOR borrowings, or at Citibank's base rate plus 2 00  for the term of the loan and 2 50  for the revolving credit facility  The Company is required to pay fees of 0 50  per annum on the daily unused amount of the revolving facility  Amortization payments of $2,875 related to the term loan will begin on May 31, 2004, and continue on a quarterly basis until February 28, 2008, with a final payment of $1,104,000 due April 30, 2008 Substantially all of Rite Aid Corporation's wholly owned subsidiaries guarantee the obligations under the new senior secured credit facility  The subsidiary guarantees are secured by a first priority lien on, among other things, the inventory, accounts receivable and prescription files of the subsidiary guarantors  Rite Aid Corporation is a holding company with no direct operations and is dependent upon dividends, distributions and other payments from its subsidiaries to service payments under the new senior secured credit facility  Rite Aid Corporation's direct obligations under the new senior secured credit facility are unsecured, The new senior secured credit facility allows for the issuance of up to $150,000 in additional term loans or additional revolver availability  The Company may request the additional loans at any time prior to the maturity of the senior secured credit facility, provided that the Company is not in default of any terms of the facility, nor is in violation of any financial covenants  The new senior secured credit facility allows the Company to have outstanding, at any time, up to $1,000,000 in secured debt in addition to the senior secured credit facility  At February 28, 2004, the remaining additional permitted secured debt under the new senior credit facility is $197,975  The Company has the ability to incur an unlimited amount of unsecured debt, if the terms of such unsecured indebtedness comply with certain terms set forth in the credit agreement and subject to the Company's compliance with certain financial covenants  If the Company issues unsecured debt that does not meet the credit agreement restrictions, it reduces the amount of available permitted secured debt  The new senior secured credit facility also allows for the repurchase of any debt with a maturity prior to 2008, and for a limited amount of debt with a maturity after April 30, 2008, based upon outstanding borrowings under the revolving credit facility and available cash at the time of the repurchase  The new senior secured credit facility contains customary covenants, which place restrictions on incurrence of debt, the payment of dividends, mergers, liens and sale and leaseback transactions  The new senior secured credit facility also requires meet various financial ratios and limits capital expenditures  For the twelve months ending February 26, 2005, the covenants require us to maintain a maximum leverage ratio of 6 05 1  Subsequent to February 26, 2005, the ratio gradually decreases to 3 8 1 for the twelve months ending March 1, 2008  We also maintain a minimum interest coverage ratio of 2 05 1 for the twelve months ending February 26, 2005  Subsequent to February 26, 2005, the ratio gradually increases to 3 25 1 for the twelve months ending March 1, 2008  In addition, we must maintain a minimum fixed charge ratio of 1 10 1 for the twelve months ending February 26, April 30, 61  196 RITE AID CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) For the Years Ended February 28, 2004, March 1, 2003 and March 2, 2002 (In thousands, except per share amounts) 2005  Subsequent to February 26, 2005, the ratio gradually increases to 1 25 1 for the twelve months ending March 1, 2008  Capital expenditures are limited to $386,085 for the fiscal year ending February 26, 2005, with the allowable amount increasing in subsequent years  The Company was in compliance with the covenants of the new senior secured credit facility and its other debt instruments as of February 28, 2004  With continuing improvements in operating performance, the Company anticipates that it will remain in compliance with its debt covenants  However, variations in operating performance and unanticipated developments may adversely affect the Company's ability to remain in compliance with the applicable debt covenants  The new 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 any event occurs that enables, or which with the giving of notice or the lapse of time would enable, the holder of the Company's debt to accelerate the maturity of debt having a principal amount in excess of $25,000  The Company's ability to borrow under the senior secured credit facility is based on a specified borrowing base consisting of eligible accounts receivable, inventory and prescription files  At February 28, 2004, the term loan was fully drawn and the Company had no outstanding draws on the revolving credit facility  At February 28, 2004, the Company had additional borrowing capacity of $584,804, net of outstanding letters of credit of $115,196  As a result of the placement of the new senior secured credit facility, the Company recorded a loss on debt modification in fiscal 2004 of $43,197 (which included the write off of previously deferred debt issue costs of $35,120)  On October 1, 2003, the Company paid, at maturity, remaining outstanding balance on the 6 0  dealer remarketable securities  In May 2003, the Company issued $150,000 aggregate principal amount of 9 25  senior notes due 2013  These notes are unsecured and effectively subordinate to the Company's secured debt  The indenture governing the 9 25  senior notes contains customary covenant provisions that amount other things, include limitations on the Company's ability to pay dividends, make investments or other restricted payments, incur debt, grant liens, sell assets and enter into sale lease back transactions  In April 2003, the Company issued $360,000 aggregate principal amount of 8 125  senior secured notes due 2010  The notes are unsecured, unsubordinated obligations to Rite Aid Corporation and rank equally in right of payment with all other unsecured, unsubordinated indebtedness  The Company's obligations under the notes are guaranteed, subject to certain limitations, by subsidiaries that guarantee the obligations under our new senior secured credit facility  The guarantees are secured, subject to the permitted liens, by shared second priority liens, with the holders of the Company's 12 5  senior notes and the Company's 9 5  senior secured notes, granted by subsidiary guarantors on all of their assets that secure the obligations under the new senior secured credit facility, subject to certain exceptions  The indenture governing the Company's 8 125  senior secured notes contains customary covenant provisions that, among other things, include limitations on our ability to pay dividends, make investments or other restricted payments, incur debt, grant liens, sell assets and enter into sales lease back transactions  62  197  RITE AID CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) For the Years Ended February 28, 2004, March 1, 2003 and March 2, 2002 (In thousands, except per share amounts) During fiscal 2004 the Company repurchased the following securities  Debt Repurchased 6 0  fixed rate senior notes due 2005 7 125  notes due 2007  6 875  senior debentures due 2013 7 7  notes due 2027 6 875  fixed rate senior notes due 2028  12 5  senior secured notes due 2006 Total Principal Amount Repurchased $ 37,848 124,926 15,227 5,000 10,000 10,000 $203,001 Amount Paid $ 36,853 120,216 13,144 4,219 7,975 11,275 $193,682 (Gain) luss $ (865) (4,314) (1,981) (715) (1,895) 1,888 $(7,882) 2003 Transactions  Senior Secured Notes  The Company issued $300,000 of 9 5  senior secured notes due 2011 in February 2003  The notes were unsecured, unsubordinated obligations of the Company and rank equally in right of payment with all of the Company's other unsecured, unsubordinated indebtedness  The Company's obligations under the notes are guaranteed, subject to certain limitations, by subsidiaries that guarantee the obligations under the senior secured credit facility  The guarantees are secured, subject to the permitted liens, by shared second priority liens with the holders of the 12 5  senior notes and the 8 125  senior secured notes, granted by subsidiary guarantors on all assets that secure the Company's obligations under the senior secured credit facility, subject to certain limitations  Proceeds from these notes were used to redeem all the $149,500 of the Company's senior secured (shareholders) notes due 2006 as well as to fund other debt repurchases and general corporate purposes  Repurchase of Debt  The Company repurchased $25,425 of its 6 0  dealer remarketable securities due 2003, $118,605 of its 6 0  notes due 2005, and $15,000 of its 7 125  notes due 2007 during fiscal 2003  In addition to the debt repurchases noted above, the Company retired $150,500 of its 5 25  convertible subordinated notes at maturity in September 2002, and made quarterly mandatory repayments on the senior secured credit facility term loan totaling $27,500 during fiscal 2003  These fiscal 2003 transactions resulted in a gain of $13,628 on debt retirements and modifications  2002 Refinancing and Other Transactions  On June 27, 2001, the Company completed a major financial restructuring that extended the maturity dates of the majority of its debt to 2005 or beyond, provided additional equity and converted a portion of its debt to equity  These transactions are described below  Senior Secured Credit Facility  The Company entered into a new $1,900,000 senior secured credit facility  This facility was replaced by the new senior secured credit facility discussed above  High Yield Notes  The Company issued $150,000 of 11 25  senior notes due July 2008  These notes are unsecured and are effectively subordinate to the secured debt of the Company, Debt for Debt Exchange  The Company cxchanged $152,025 of its cxisting 10 5  senior secured notes due 2002 for an equal amount of 12 5  senior notes due September 2006  In addition, holders of these notes received warrants to purchase 3,000 shares of Company common stock at $6 00 share  On June 29, 2001, the warrant holders exercised these warrants, on a cashless basis, and as a result approximately 982 shares of common stock were issued  63  198 During the third quarter of fiscal 2004, the Company recorded a non recurring income tax benefit, driven by the approval by the Congressional Joint Committee on Taxation on the conclusions of the Internal Revenue Service examination of the Company's federal tax returns for the fiscal years 1996 through 2000  During the first quarter of fiscal 2004, the Company recorded a loss on debt modification of $43,197 related to the placement of its new senior secured credit facility  During the fourth quarter of fiscal 2003, the Company incurred $78,277 in store closing and impairment charges  The Company also recorded a $27,700 million credit related to the elimination of several liabilities for former executives and a $19,502 million reduction of its LIFO reserve related to a lower level of inflation than originally estimated  During the second quarter of fiscal 2003, the Company incurred $58,223 in store closing and impairment charges  In the first quarter of fiscal 2003, the company incurred a charge of $20,000 to reserve for probable loss related to the U S  Attorney's investigation of former management's business practices  The Company also recorded a tax benefit of $44,011 related to a tax law change that increased the carryback period from two years to five for certain net operating losses  20  Financial Instruments The carrying amounts and fair values of financial instruments at February 28, 2004 and March 1, 2003 are listed as follows  2004 2003 Carrying Fair Carrying Fuir Amount Value Amount Value Variable rate indebtedness  $1,150,000 $1,150,000 $1,372,500 $1,372,500 Fixed rate indebtedness $2,558,497 $2 640,995 $2,313,942 $2,027,603 Cash, trade receivables and trade payables are carried at market value, which approximates their fair values due to the short term maturity of these instruments  The following methods and assumptions were used in estimating fair value disclosures for financial instruments  LIBOR based borrowings under credit facilities The carrying amounts for LIBOR based borrowings under the credit facilities, term loans and term notes approximate their fair values due to the short term nature of the obligations and the variable interest rates  Long term indebtedness  The fair values of long term indebtedness is estimated based on the quoted market prices of the financial instruments  If quoted market prices were not available, the Company estimated the fair value based on the quoted market price of a financial instrument with similar characteristics  79 e  Consider the 8 125  notes due 2010  Assume that Rite Aid issued these notes on May 1, 2003 and that the company pays interest on the last day of April each year  i  According to a press release issued by Rite Aid at the time of the issuance, the proceeds of the notes issue were 98 688  of the face value of the notes  Prepare the journal entry that Rite Aid must have made when these notes were issued  ii  At what effective annual rate of interest were these notes issued  iii  Assume that Rite Aid uses the effective interest rate method to account for this debt  Use the guidance for the table that follows to prepare an amortization schedule for these notes  Use the last column to verify that each year's interest expense uses the same interest rate even though the expense changes  Interest Interest Bond Discount Net Book Effective Date Payment Expense Amortization Value of Debt Interest Rate May 1, 2003 $ 355,276 80 May 1, 2004 $ 29,250 May 1, 2005 May 1 2006 May 1, 2007 May 1, 2008 May 1, 2009 May 1, 2010     o May 1, 2003 Net Book Value is the initial proceeds of the bond issuance, net of costs  The face value of this debt is $360,000, the discount is $4,723 20  the coupon rate is 8 125  and the effective rate (including fees) is 8 3803   Interest Payment is the face value of the bond times the coupon rate of the bond  Interest Expense equals opening book value of the debt times the effective interest rate  The difference between the interest payment and interest expense is the amortization of the bond discount  This is equivalent to saying that interest expense equals the interest paid plus the amortization of the bond discount  O Amortizing the discount increases the net book value of the bond  Prepare the journal entry that Rite Aid must have recorded February 28, 2004 to accrue interest expense on these notes  Based on your answer to part iv  what is the book value of the notes at February 28, 2004  Your answer to part v  will be different from the amount that Rite Aid reported because the company used the straight line method to amortize the discount on these notes instead of the effective interest rate method  Use the guidance that follows to complete the following table using the straight line method to amortize the bond discount  Use the last column in the table to record the interest rate each year  Under this method, does Rite Aid report the same interest rate on these notes each year  iv  V  vi  vii  Compare the year by year difference in interest expense derived from each method  What pattern do you observe  Is the difference material in any year   191  RITE AID CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except per share amounts) February 28, 2004 March 1  2003 365,321 ASSETS Current assets  Cash and cash equivalents Accounts receivable, net Inventories, net         Prepaid expenses and other current assets Total current assets Property, plant and equipment, net Goodwill Other intangibles, net Other assets Total assets $ 334,755 670,004 2,223,171 150,067 3,377,997 1,883,808 684,535 176,672 123,667 $ 6,246,679 $ 575,518 2,195,030 108,018 3,243,887 1,868,579 684,535 199,768 136,746 $ 6,133,515 $ 23,976 758,290 701,484 1,483,750 246,000 3,451,352 170,338 885,975 6,237,415 $ 103,715 755,284 707,999 1,566,998 244,500 3,345,365 169,048 900,270 6,226,181 LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities  Short term debt and current maturities of convertible notes, long term debt and lease financing obligations Accounts payable             Accrued salaries, wages and other current liabilities Total current liabilities Convertible notes Long term debt, less current maturitics Lease financing obligations, less current maturities Other noncurrent liabilities Total liabilities Commitments and contingencies Redeemable preferred stock Stockholders' equity (deficit)  Preferred stock, par value $1 per share  liquidation value $100 per share  20,000 shares authorized  shares issued   4,178 and 3,937 Common stock, par value $1 per share  1,000,000 shares authorized  shares issued and outstanding 516,496 and 515,115 Additional paid in capital     Accumulated deficit Stock based and deferred compensation Accumulated other comprehensive loss Total stockholders' equity (deficit) Total liabilities and stockholders' equity (deficit)  19,663 417,803 393,705 516,496 3,133,277 (4 035,433) 515,115 3,119,619 (4,118,119) 5,369 (28,018) (112,329 $ 6,133,515 (22,879) 9,264 $ 6,246,679 The accompanying notes are an integral part of these consolidated financial statements  41  192  RITE AID CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts) Year Ended March 1, 2003 $15,791,278 February 28, 2004 $16,600,449 March 2 2007 $15,166,170 12,568,405 3,594,405 12,035,537 3,471,573 4,806 11,697,912 3,422,383 (15,891) 29,821 21,007 Revenues  Costs and expenses  Cost of goods sold, including occupancy costs Selling, general and administrative expenses Stock based compensation expense (benefit) Goodwill amortization  Store closing and impairment charges Interest expense   Interest rate swap contracts Loss (gain) on debt modifications and retirements, net   Share of loss from equity investments Loss (gain) on sale of assets and investments, net      22,466 313,498 135,328 330,020 278 251,617 396,064 41,894 35,315 (13,628) 2,023 16,565,933 34,516 (48,795) 83,311 (18,620) 15,945,294 (154,016) (41,940) $ (112,076) 221,054 12,092 (42,536 16,005,596 (839,426) (11,745) (827,681) Income (loss) before income taxes Income tax bencfil    Net income (loss)  Computation of income (loss) applicable to common stockholders  Net income (loss)           Accretion of redeemable preferred stock Preferred stock beneficial conversion Cumulative preferred stock dividends Net income (loss) applicable to common stockholders  Basic and diluted income (loss) per share  Net income (loss) per share  $ (112,076) (102) 83,311 (102) (625) (24 098) 58,486 $ (827,681) (104) (6,406) (27 530) $ (861,721) (32,201) $ (144,379) $ 0 11 (0 28) $ (1 82) The accompanying notes are an integral part of these consolidated financial statements  42  193 RITE AID CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) February 28, 2004 Year Ended March 1 21N13 March 2 2002 $ 83,311 $(112,076) $ (827,681) 264 288 22,466 285,334 135,328 278 (18,620) 4,806 349,840 251,617 41,894 (42,536) (15,891) 2,023 29,821 35,315 (13,628) 221,054 Changes in (94,486) (48,014) (61,209) (17,162) 11,162 227,515 14 803 40,555 24,018 (62,314) 6,899 305,383 (69,004) 112,649 (14,635) (5,004) 14,040 16,343 Operating Activities  Net income (loss)  Adjustments to reconcile to net cash provided by operations  Depreciation and amortization Store closings and impairment loss Interest rate swap contracts         Loss (gain) on sale of assets and investments, net    Stock based compensation expense (benefit) Loss (gain) on debt modifications and retirements, nel     in operating assets and liabilities  Accounts receivable  Inventories  Income taxes receivable payable Accounts payable  Other assets and liabilities, net Net cash provided by operating activities Investing Activities  Expenditures for property, plant and equipment     Intangible assets acquired  Proceeds from the sale of Advance PCS securities and notes    Proceeds from dispositions  Net cash (used in provided by investing activities Financing activities  Net proceeds from the issuance of long term debt Net change in bank credit facilities   Proceeds from the issuance of bonds  Principal payments on long term debt Change in zero balance cash account  Net proceeds from the issuance of common stock   Deferred financing costs paid    Net cash used in financing activities  Increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year (250,668) (16,705) (104,507) (11,647) (175,183) (12,200) 25,223 484,214 45 700 43,940 (242,150) (72,214) 342,531 1,378,462 (222,500) 502,950 (264,324) (4 613) 3,541 (30,985) (15,931) (30,566) 365,321 $ 334,755 (5 962) 300,000 (477 466) (12,936) 279 (15,818) (211,903) 21 266 344,055 $365,321 392,500 (2,277,431) (48,131) 530,589 (83,098) (107,109) 251,765 92 290 344,055 The accompanying notes are an integral part of these consolidated financial statements  45  194  RITE AID CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) For the Years Ended February 28, 2004, March 1, 2003 and March 2, 2002 (In thousands, except per sbare amounts) 10  Indebtedness and Credit Agreements Following is a summary of indebtedness and lease financing obligations at February 28, 2004 and March 1, 2003  February 28, 2004 March 1, 2003 $1,150,000 1,372,500 Secured Debt  Senior secured credit facility due April 2008 Senior secured credit facility due March 2005 12 5  senior secured notes due September 2006 ($142,025 and $152,025 face value less unamortized discount of $4,158 and 6,143)                8 125  senior secured notes due May 2010 ($360,000 face value less unamortized discount of $4,168) 9 5  senior secured notes due February 2011 Other 137,867 145,882 355,832 300,000 5,125 1,948,824 183 169 300,000 6,540 1,824,922 176,186 198,000 38,047 58,125 198,000 75,895 Lease Financing Obligations  Unsecured Debt  6 0  dealer remarketable securities due October 2003 7 625  senior notes due April 2005    6 0  fixed rate senior notes due December 2005 4 75  convertible potes due December 2006 ($250,000 face value less unamortized discount of $4,000 and $5,500) 7 125  notes due January 2007     11 25  senior notes due July 2008  son 6 125  fixed rate senior notes due December 2008  0 125 9 25  senior notes due Junc 2013 ($150,000 face value less unamortized discount of $2,221) 6 875  senior debentures due August 2013 7 7  notes due February 2027            6 875  fixed rate senior notes due December 2028 246,000 210,074 150,000 150,000 244,500 335,000 150 000 150,000 147,779 184,773 295 000 140,000 1,759,673 200,000 300,000 150,000 1,861,520 3,891,666 3,862,628 (23 976) (103,715) Total debt      Short term debt and current maturities of convertible notes, long  term debt and lease financing obligations  Long term debt and lease financing obligations, less current maturities      $3,867,690 $3,758,913 60  195 RITE AID CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) For the Years Ended February 28, 2004, March 1, 2003 and March 2, 2002 (In thousands, except per share amounts) 2004 Transactions New Credit Facility  On May 28, 2003, the Company replaced its senior secured credit facility with a new senior secured credit facility  The new facility consists of a $1,150,000 term loan and a $700,000 revolving credit facility, and will mature on April 30, 2008  The proceeds of the loans made on the closing of the new credit facility were, among other things, used repay the outstanding amounts under the old facility and to purchase the land and buildings at the Company's Perryman, MD and Lancaster, CA distribution centers, which had previously been leased through a synthetic lease arrangement  On August 4, 2003, the Company amended and restated the senior secured credit facility, which reduced the interest rate on term loan borrowings under the scnior secured credit facility by 50 basis points  Borrowings under the new facility currently bear interest either at LIBOR plus 3 00  for the term loan and 3 50  for the revolving credit facility, if the Company chooses to make LIBOR borrowings, or at Citibank's base rate plus 2 00  for the term of the loan and 2 50  for the revolving credit facility  The Company is required to pay fees of 0 50  per annum on the daily unused amount of the revolving facility  Amortization payments of $2,875 related to the term loan will begin on May 31, 2004, and continue on a quarterly basis until February 28, 2008, with a final payment of $1,104,000 due April 30, 2008 Substantially all of Rite Aid Corporation's wholly owned subsidiaries guarantee the obligations under the new senior secured credit facility  The subsidiary guarantees are secured by a first priority lien on, among other things, the inventory, accounts receivable and prescription files of the subsidiary guarantors  Rite Aid Corporation is a holding company with no direct operations and is dependent upon dividends, distributions and other payments from its subsidiaries to service payments under the new senior secured credit facility  Rite Aid Corporation's direct obligations under the new senior secured credit facility are unsecured, The new senior secured credit facility allows for the issuance of up to $150,000 in additional term loans or additional revolver availability  The Company may request the additional loans at any time prior to the maturity of the senior secured credit facility, provided that the Company is not in default of any terms of the facility, nor is in violation of any financial covenants  The new senior secured credit facility allows the Company to have outstanding, at any time, up to $1,000,000 in secured debt in addition to the senior secured credit facility  At February 28, 2004, the remaining additional permitted secured debt under the new senior credit facility is $197,975  The Company has the ability to incur an unlimited amount of unsecured debt, if the terms of such unsecured indebtedness comply with certain terms set forth in the credit agreement and subject to the Company's compliance with certain financial covenants  If the Company issues unsecured debt that does not meet the credit agreement restrictions, it reduces the amount of available permitted secured debt  The new senior secured credit facility also allows for the repurchase of any debt with a maturity prior to 2008, and for a limited amount of debt with a maturity after April 30, 2008, based upon outstanding borrowings under the revolving credit facility and available cash at the time of the repurchase  The new senior secured credit facility contains customary covenants, which place restrictions on incurrence of debt, the payment of dividends, mergers, liens and sale and leaseback transactions  The new senior secured credit facility also requires meet various financial ratios and limits capital expenditures  For the twelve months ending February 26, 2005, the covenants require us to maintain a maximum leverage ratio of 6 05 1  Subsequent to February 26, 2005, the ratio gradually decreases to 3 8 1 for the twelve months ending March 1, 2008  We also maintain a minimum interest coverage ratio of 2 05 1 for the twelve months ending February 26, 2005  Subsequent to February 26, 2005, the ratio gradually increases to 3 25 1 for the twelve months ending March 1, 2008  In addition, we must maintain a minimum fixed charge ratio of 1 10 1 for the twelve months ending February 26, April 30, 61  196 RITE AID CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) For the Years Ended February 28, 2004, March 1, 2003 and March 2, 2002 (In thousands, except per share amounts) 2005  Subsequent to February 26, 2005, the ratio gradually increases to 1 25 1 for the twelve months ending March 1, 2008  Capital expenditures are limited to $386,085 for the fiscal year ending February 26, 2005, with the allowable amount increasing in subsequent years  The Company was in compliance with the covenants of the new senior secured credit facility and its other debt instruments as of February 28, 2004  With continuing improvements in operating performance, the Company anticipates that it will remain in compliance with its debt covenants  However, variations in operating performance and unanticipated developments may adversely affect the Company's ability to remain in compliance with the applicable debt covenants  The new 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 any event occurs that enables, or which with the giving of notice or the lapse of time would enable, the holder of the Company's debt to accelerate the maturity of debt having a principal amount in excess of $25,000  The Company's ability to borrow under the senior secured credit facility is based on a specified borrowing base consisting of eligible accounts receivable, inventory and prescription files  At February 28, 2004, the term loan was fully drawn and the Company had no outstanding draws on the revolving credit facility  At February 28, 2004, the Company had additional borrowing capacity of $584,804, net of outstanding letters of credit of $115,196  As a result of the placement of the new senior secured credit facility, the Company recorded a loss on debt modification in fiscal 2004 of $43,197 (which included the write off of previously deferred debt issue costs of $35,120)  On October 1, 2003, the Company paid, at maturity, remaining outstanding balance on the 6 0  dealer remarketable securities  In May 2003, the Company issued $150,000 aggregate principal amount of 9 25  senior notes due 2013  These notes are unsecured and effectively subordinate to the Company's secured debt  The indenture governing the 9 25  senior notes contains customary covenant provisions that amount other things, include limitations on the Company's ability to pay dividends, make investments or other restricted payments, incur debt, grant liens, sell assets and enter into sale lease back transactions  In April 2003, the Company issued $360,000 aggregate principal amount of 8 125  senior secured notes due 2010  The notes are unsecured, unsubordinated obligations to Rite Aid Corporation and rank equally in right of payment with all other unsecured, unsubordinated indebtedness  The Company's obligations under the notes are guaranteed, subject to certain limitations, by subsidiaries that guarantee the obligations under our new senior secured credit facility  The guarantees are secured, subject to the permitted liens, by shared second priority liens, with the holders of the Company's 12 5  senior notes and the Company's 9 5  senior secured notes, granted by subsidiary guarantors on all of their assets that secure the obligations under the new senior secured credit facility, subject to certain exceptions  The indenture governing the Company's 8 125  senior secured notes contains customary covenant provisions that, among other things, include limitations on our ability to pay dividends, make investments or other restricted payments, incur debt, grant liens, sell assets and enter into sales lease back transactions  62  197  RITE AID CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) For the Years Ended February 28, 2004, March 1, 2003 and March 2, 2002 (In thousands, except per share amounts) During fiscal 2004 the Company repurchased the following securities  Debt Repurchased 6 0  fixed rate senior notes due 2005 7 125  notes due 2007  6 875  senior debentures due 2013 7 7  notes due 2027 6 875  fixed rate senior notes due 2028  12 5  senior secured notes due 2006 Total Principal Amount Repurchased $ 37,848 124,926 15,227 5,000 10,000 10,000 $203,001 Amount Paid $ 36,853 120,216 13,144 4,219 7,975 11,275 $193,682 (Gain) luss $ (865) (4,314) (1,981) (715) (1,895) 1,888 $(7,882) 2003 Transactions  Senior Secured Notes  The Company issued $300,000 of 9 5  senior secured notes due 2011 in February 2003  The notes were unsecured, unsubordinated obligations of the Company and rank equally in right of payment with all of the Company's other unsecured, unsubordinated indebtedness  The Company's obligations under the notes are guaranteed, subject to certain limitations, by subsidiaries that guarantee the obligations under the senior secured credit facility  The guarantees are secured, subject to the permitted liens, by shared second priority liens with the holders of the 12 5  senior notes and the 8 125  senior secured notes, granted by subsidiary guarantors on all assets that secure the Company's obligations under the senior secured credit facility, subject to certain limitations  Proceeds from these notes were used to redeem all the $149,500 of the Company's senior secured (shareholders) notes due 2006 as well as to fund other debt repurchases and general corporate purposes  Repurchase of Debt  The Company repurchased $25,425 of its 6 0  dealer remarketable securities due 2003, $118,605 of its 6 0  notes due 2005, and $15,000 of its 7 125  notes due 2007 during fiscal 2003  In addition to the debt repurchases noted above, the Company retired $150,500 of its 5 25  convertible subordinated notes at maturity in September 2002, and made quarterly mandatory repayments on the senior secured credit facility term loan totaling $27,500 during fiscal 2003  These fiscal 2003 transactions resulted in a gain of $13,628 on debt retirements and modifications  2002 Refinancing and Other Transactions  On June 27, 2001, the Company completed a major financial restructuring that extended the maturity dates of the majority of its debt to 2005 or beyond, provided additional equity and converted a portion of its debt to equity  These transactions are described below  Senior Secured Credit Facility  The Company entered into a new $1,900,000 senior secured credit facility  This facility was replaced by the new senior secured credit facility discussed above  High Yield Notes  The Company issued $150,000 of 11 25  senior notes due July 2008  These notes are unsecured and are effectively subordinate to the secured debt of the Company, Debt for Debt Exchange  The Company cxchanged $152,025 of its cxisting 10 5  senior secured notes due 2002 for an equal amount of 12 5  senior notes due September 2006  In addition, holders of these notes received warrants to purchase 3,000 shares of Company common stock at $6 00 share  On June 29, 2001, the warrant holders exercised these warrants, on a cashless basis, and as a result approximately 982 shares of common stock were issued  63  198 During the third quarter of fiscal 2004, the Company recorded a non recurring income tax benefit, driven by the approval by the Congressional Joint Committee on Taxation on the conclusions of the Internal Revenue Service examination of the Company's federal tax returns for the fiscal years 1996 through 2000  During the first quarter of fiscal 2004, the Company recorded a loss on debt modification of $43,197 related to the placement of its new senior secured credit facility  During the fourth quarter of fiscal 2003, the Company incurred $78,277 in store closing and impairment charges  The Company also recorded a $27,700 million credit related to the elimination of several liabilities for former executives and a $19,502 million reduction of its LIFO reserve related to a lower level of inflation than originally estimated  During the second quarter of fiscal 2003, the Company incurred $58,223 in store closing and impairment charges  In the first quarter of fiscal 2003, the company incurred a charge of $20,000 to reserve for probable loss related to the U S  Attorney's investigation of former management's business practices  The Company also recorded a tax benefit of $44,011 related to a tax law change that increased the carryback period from two years to five for certain net operating losses  20  Financial Instruments The carrying amounts and fair values of financial instruments at February 28, 2004 and March 1, 2003 are listed as follows  2004 2003 Carrying Fair Carrying Fuir Amount Value Amount Value Variable rate indebtedness  $1,150,000 $1,150,000 $1,372,500 $1,372,500 Fixed rate indebtedness $2,558,497 $2 640,995 $2,313,942 $2,027,603 Cash, trade receivables and trade payables are carried at market value, which approximates their fair values due to the short term maturity of these instruments  The following methods and assumptions were used in estimating fair value disclosures for financial instruments  LIBOR based borrowings under credit facilities The carrying amounts for LIBOR based borrowings under the credit facilities, term loans and term notes approximate their fair values due to the short term nature of the obligations and the variable interest rates  Long term indebtedness  The fair values of long term indebtedness is estimated based on the quoted market prices of the financial instruments  If quoted market prices were not available, the Company estimated the fair value based on the quoted market price of a financial instrument with similar characteristics  79

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e. Consider the 8.125% notes due 2010. Assume that Rite Aid issued these notes on May 1, 2003 and that the company pays interest on

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