<PAGE> 1
EXHIBIT 99.3
CONSOLIDATED FINANCIAL STATEMENTS
PCS Holding Corporation and Subsidiaries
February 26, 2000
<PAGE> 2
PCS Holding Corporation and Subsidiaries
Consolidated Financial Statements
As of February 27, 1999 and February 26, 2000 and
for the Thirty-Six Days Ended February 27, 1999 and
the Year Ended February 26, 2000
CONTENTS
<TABLE>
<S> <C>
Report of Independent Auditors....................................................................................1
Consolidated Financial Statements
Consolidated Balance Sheets.......................................................................................2
Consolidated Statements of Operations.............................................................................3
Consolidated Statements of Shareholder's Equity...................................................................4
Consolidated Statements of Cash Flows.............................................................................5
Notes to Consolidated Financial Statements........................................................................6
</TABLE>
<PAGE> 3
Report of Independent Auditors
Board of Directors and Shareholder
PCS Holding Corporation
We have audited the accompanying consolidated balance sheets of PCS Holding
Corporation and Subsidiaries (the Company) as of February 27, 1999 and February
26, 2000, and the related consolidated statements of operations, shareholder's
equity, and cash flows for the thirty-six days ended February 27, 1999 and the
year ended February 26, 2000. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of PCS
Holding Corporation and Subsidiaries at February 27, 1999 and February 26, 2000,
and the consolidated results of their operations and their cash flows for the
thirty-six days ended February 27, 1999 and the year ended February 26, 2000, in
conformity with accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
April 21, 2000, except for Note 12
for which the date is June 15, 2000
1
<PAGE> 4
PCS Holding Corporation and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands, except par values)
<TABLE>
<CAPTION>
FEBRUARY 27, FEBRUARY 26,
1999 2000
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 1,955 $ 3,585
Accounts receivable, less allowances of $9,746 in 1999
and $5,494 in 2000 531,017 613,933
Other receivables 674 1,391
Inventories 32,464 37,952
Prepaid expenses 2,718 4,742
Deferred income taxes 10,156 46
------------ ------------
Total current assets 578,984 661,649
Goodwill, net of amortization of $3,171 in 1999 and
$35,235 in 2000 1,282,918 1,250,854
Other intangibles, net 618,005 607,792
Property and equipment, net 76,882 94,734
------------ ------------
Total assets $ 2,556,789 $ 2,615,029
============ ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities:
Claims and rebates payable $ 469,497 $ 518,246
Checks outstanding in excess of bank balances 93,987 367,419
Due to Rite Aid Corporation 97,420 --
Other 126,881 185,408
------------ ------------
Total current liabilities 787,785 1,071,073
Noncurrent liabilities:
Deferred income taxes 238,127 232,525
Other liabilities 11,978 15,181
Shareholder's equity:
Class A voting common stock, $1 par value; 1,000 shares authorized;
565 shares outstanding 1 1
Additional paid-in capital 1,518,472 1,274,327
Retained earnings 426 21,922
------------ ------------
Total shareholder's equity 1,518,899 1,296,250
------------ ------------
Total liabilities and shareholder's equity $ 2,556,789 $ 2,615,029
============ ============
</TABLE>
See accompanying notes.
2
<PAGE> 5
PCS Holding Corporation and Subsidiaries
Consolidated Statements of Operations
(Dollars in thousands)
<TABLE>
<CAPTION>
THIRTY-SIX
DAYS ENDED YEAR ENDED
FEBRUARY 27, FEBRUARY 26,
1999 2000
------------ ------------
<S> <C> <C>
REVENUE
Mail order programs $ 67,368 $ 753,125
Manufacturer programs 17,797 235,101
Claims processing 12,996 199,946
Other 6,165 76,522
------------ ------------
104,326 1,264,694
EXPENSES
Cost of goods and services 86,599 1,057,413
Selling, general and administrative 10,967 122,052
Amortization of goodwill 3,171 32,064
Interest expense (income), net 262 (5,867)
------------ ------------
100,999 1,205,662
------------ ------------
Income before income taxes 3,327 59,032
Income tax expense 2,901 37,536
------------ ------------
Net income $ 426 $ 21,496
============ ============
</TABLE>
See accompanying notes.
3
<PAGE> 6
PCS Holding Corporation and Subsidiaries
Consolidated Statements of Shareholder's Equity
(Dollars in thousands)
<TABLE>
<CAPTION>
CLASS A STOCK
----------------------------- ADDITIONAL
NUMBER OF PAR PAID-IN RETAINED
SHARES VALUE CAPITAL EARNINGS TOTAL
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Initial capitalization on January 23, 1999
through purchase of Class A shares by
Rite Aid Corporation 565 $ 1 $ 1,518,472 $ -- $ 1,518,473
Net income -- -- -- 426 426
------------ ------------ ------------ ------------ ------------
Balance at February 27, 1999 565 1 1,518,472 426 1,518,899
Net income -- -- -- 21,496 21,496
Due from Rite Aid Corporation -- -- (244,145) -- (244,145)
------------ ------------ ------------ ------------ ------------
Balance at February 26, 2000 565 $ 1 $ 1,274,327 $ 21,922 $ 1,296,250
============ ============ ============ ============ ============
</TABLE>
See accompanying notes.
4
<PAGE> 7
PCS Holding Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars in thousands)
<TABLE>
<CAPTION>
THIRTY-SIX DAYS
ENDED YEAR ENDED
FEBRUARY 27, FEBRUARY 26,
1999 2000
---------------- ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 426 $ 21,496
Adjustments to reconcile net income to net cash (used in) provided by
operating activities:
Depreciation and amortization 7,064 72,217
Loss on asset disposal -- 230
Provision for losses on receivables and other allowances 1,591 11,291
Changes in deferred taxes (4,627) 4,508
Changes in operating assets and liabilities:
Receivables (146,518) (84,771)
Inventories (5,731) (5,488)
Prepaid expenses (1,346) (2,024)
Claims and rebates payable 121,333 48,749
Checks outstanding in excess of bank balances (208,983) 273,432
Accrued and other liabilities 21,863 51,577
------------ ------------
Net cash (used in) provided by operating activities (214,928) 391,217
INVESTING ACTIVITIES
Additions to property and equipment, net (1,555) (28,581)
Additions to other intangibles (2,650) (19,441)
------------ ------------
Net cash used in investing activities (4,205) (48,022)
FINANCING ACTIVITIES
Change in due to (from) Rite Aid Corporation 217,133 (341,565)
------------ ------------
Net cash provided by (used in) financing activities 217,133 (341,565)
------------ ------------
Net (decrease) increase in cash (2,000) 1,630
Cash at beginning of period 3,955 1,955
------------ ------------
Cash at end of period $ 1,955 $ 3,585
============ ============
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest $ 370 $ 1,612
============ ============
Cash paid for income taxes $ -- $ 2,272
============ ============
</TABLE>
See accompanying notes.
5
<PAGE> 8
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands)
1. DESCRIPTION OF BUSINESS
PCS Holding Corporation and Subsidiaries (the "Company") is an
information-driven health solutions company operating in the United States. The
Company provides managed pharmaceutical-related programs and services that can
directly and positively improve the health of patients, and help reduce health
care costs.
Prior to January 23, 1999, the Company was a wholly owned subsidiary of Eli
Lilly and Company ("Lilly"). On January 23, 1999, Rite Aid Corporation ("Rite
Aid") purchased all outstanding shares of the Company's stock for $1.5 billion
(accounted for under the purchase method), and at February 26, 2000 continues to
own all outstanding shares of the Company's stock.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements of the Company include PCS
Holding Corporation and its wholly owned subsidiaries. All intercompany balances
and transactions have been eliminated in consolidation.
Rite Aid's purchase of the Company has been accounted for under the purchase
method of accounting, with the purchase price and related fees of the
acquisition allocated to the assets acquired and liabilities assumed based on
their estimated fair values at the date of the acquisition. The excess of cost
over the fair value of net assets acquired of approximately $1,868,589 was first
allocated to identifiable intangible assets, and then to goodwill.
Management believes that the consolidated statements of operations include an
appropriate allocation of all material costs incurred by Rite Aid on the
Company's behalf. These consolidated financial statements, however, may not be
indicative of the Company's financial position and operations if it were a stand
alone company.
Use of Estimates
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets, liabilities,
revenue, expenses and related disclosures at the date of the consolidated
financial statements and during the reporting period. Actual results could
differ from those estimates.
6
<PAGE> 9
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Concentrations of Credit Risk
Financial instruments that subject the Company to credit risk consist
principally of (i) claims reimbursement receivables and claim fees receivable
and (ii) the Company's portion of manufacturer program receivables. The Company
monitors the credit worthiness of the customers to which it grants credit terms
in the normal course of business and takes deposits from customers when
considered necessary to collateralize its position. Concentrations of credit
risk associated with these receivables are considered minimal due to a diverse,
geographically dispersed customer base, contracts with whom are subject to
periodic renewal.
Manufacturer program receivables (included in accounts receivable) are
concentrated in the drug manufacturing industry and had a net balance of $82,717
at February 27, 1999 and $99,356 at February 26, 2000.
Cash and Cash Equivalents
Cash and cash equivalents include all highly liquid financial instruments
purchased with a maturity of three months or less, and the carrying value
approximates fair value.
Accounts Receivable and Claims and Rebates Payable
Accounts receivable consists primarily of claims reimbursement receivables,
claims processing fees receivable and manufacturer program receivables. Because
these items are short-term in nature, their carrying amounts approximate fair
value.
Claims reimbursement receivables and claims payables arise from the adjudication
of pharmacy claims. These amounts, along with the related claim fees receivable,
are recorded when a reimbursement request is received by the Company.
Reimbursements for claim payments are not included in revenue, and payments to
member pharmacies are not included in expenses, unless they are part of a
capitated program for which the Company takes the risk for the pharmaceutical
cost. Checks outstanding are classified as liabilities because they are drawn on
zero balance accounts.
Manufacturers' rebates receivable and rebates payable arise from manufacturers'
rebate programs and are recorded when a claim eligible for rebate is adjudicated
by the Company. Rebates are paid to customers upon collection from
manufacturers, and are either contractually limited to actual collections from
manufacturers or are, in certain limited circumstances, guaranteed for a certain
rebate per claim. The Company generally is paid a portion of rebates collected
as a rebate processing fee. The customer portion of rebates collected is not
included in revenue, and correspondingly payments of rebates to customers are
not included in expenses.
7
<PAGE> 10
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company participates in Rite Aid's accounts receivable securitization
program, whereby Rite Aid and certain of its subsidiaries sell, on an ongoing
basis, a pool of receivables to a wholly owned bankruptcy-remote special purpose
funding subsidiary of Rite Aid. Under the securitization program, new
receivables are sold as collections reduce previously sold accounts receivable.
The Company services, administers and collects the receivables on behalf of the
purchaser. The Company had accounts receivable of approximately $-0- at February
27, 1999 and $1,534 at February 26, 2000 which it was servicing but which had
been sold under the securitization program (and the proceeds from the sale are
included in the balance due from Rite Aid Corporation).
Due from Rite Aid Corporation
The Company participates in the daily cash management program of Rite Aid,
through which it invests excess cash and has access to short-term borrowings.
Under the program, the Company pays or receives interest on its balances in the
program at approximately 5.5 percent.
The due from Rite Aid Corporation balance at February 26, 2000 is reflected as a
reduction of additional paid-in capital as it is Rite Aid's intention not to
repay the balance to the Company, except to the extent funds are needed for the
Company's current operations. The balance due to Rite Aid at February 27, 1999,
however, is included in current liabilities as it was repaid to Rite Aid.
Inventories
Inventories consist primarily of pharmaceutical products for mail order
programs. Inventories are recorded at the lower of cost or market. Cost is
determined using the first-in, first-out method.
Deferred Income Taxes
Deferred income taxes are recognized for the future tax effects of temporary
differences between financial and income tax reporting based on enacted tax laws
and rates.
Goodwill
Goodwill represents the amount of the purchase price of the Company's stock paid
by Rite Aid in excess of the identifiable net assets acquired, and is amortized
on a straight-line basis over 40 years.
8
<PAGE> 11
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
On a periodic basis, the Company estimates the future undiscounted cash flows of
its business to which goodwill relates to assure that the carrying value of
goodwill has not been impaired.
Other Intangibles
Other intangibles consist of those intangible assets identified at the time of
Rite Aid's purchase of the Company's stock. Provisions for amortization are
computed by the straight-line method based on the estimated useful lives of the
underlying assets as follows:
<TABLE>
<S> <C>
Trade name 40 years
Customer base 30 years
Pharmacy network 30 years
Assembled work force 6 years
Internally developed software 5 years
Capitalized software costs 2 to 8 years
</TABLE>
On a periodic basis, the Company estimates the future undiscounted cash flows of
its business to which the other intangibles relate to assure that the carrying
value of the other intangibles has not been impaired.
Property and Equipment
Property and equipment is stated at cost, less accumulated depreciation.
Provisions for depreciation are generally computed by the straight-line method
based on the estimated useful lives of the underlying assets as follows:
<TABLE>
<S> <C>
Buildings and improvements 8 to 30 years
Equipment 3 to 5 years
Furniture and fixtures 10 years
</TABLE>
When property or equipment is retired or sold, its cost and related accumulated
depreciation are written off and the resulting gain or loss is included in net
income.
9
<PAGE> 12
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Revenue
Revenue includes claims processing fees which are accrued when the related claim
is adjudicated and approved for payment. Certain of the Company's agreements
require its customers to pay a fee per covered member rather than a fee per
claim. The Company records these fees monthly based upon member counts provided
by its customers. Revenue from manufacturer programs is recognized when services
are performed. Mail order program revenue is recognized when prescriptions are
shipped. Other revenue is generally recognized as the related services are
performed.
3. OTHER INTANGIBLES
Other intangibles consist of the following:
<TABLE>
<CAPTION>
FEBRUARY 27, FEBRUARY 26,
1999 2000
------------ ------------
<S> <C> <C>
Customer base $ 357,400 $ 357,400
Trade name 113,100 113,100
Capitalized software costs 38,299 57,739
Internally developed software 21,900 21,900
Pharmacy network 76,700 76,700
Assembled work force 13,400 13,400
------------ ------------
620,799 640,239
Accumulated amortization (2,794) (32,447)
------------ ------------
$ 618,005 $ 607,792
============ ============
</TABLE>
In connection with Rite Aid's acquisition of the Company, intangible assets were
identified with an estimated fair value of $582,500. Capitalized software costs
represent cash expenditures by the Company.
Accumulated amortization on the capitalized software costs portion of other
intangibles was $436 at February 27, 1999 and $6,244 at February 26, 2000.
Amortization expense for other intangibles was $2,794 during the thirty-six days
ended February 27, 1999 and $29,653 during the year ended February 26, 2000
(which includes $436 during the thirty-six days ended February 27, 1999 and
$5,808 during the year ended February 26, 2000 for capitalized software costs).
10
<PAGE> 13
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
<TABLE>
<CAPTION>
FEBRUARY 27, FEBRUARY 26,
1999 2000
------------ ------------
<S> <C> <C>
Land $ 36,220 $ 36,444
Buildings and improvements 20,094 31,557
Equipment 10,230 18,777
Furniture and fixtures 6,780 15,135
Construction in progress 4,657 4,419
------------ ------------
77,981 106,332
Accumulated depreciation (1,099) (11,598)
------------ ------------
$ 76,882 $ 94,734
============ ============
</TABLE>
Depreciation expense was $1,099 during the thirty-six days ended February 27,
1999 and $10,499 during the year ended February 26, 2000.
5. INCOME TAXES
The Company is included in Rite Aid's consolidated federal income tax filings,
and participates in Rite Aid's tax sharing arrangement. Rite Aid's tax sharing
arrangement contemplates each subsidiary computing its federal income tax
payable or receivable as if it were filing its own separate federal tax return,
and then the subsidiary either owes or is owed the computed amount by Rite Aid
(included in the net due to/from Rite Aid Corporation balance). Under Rite Aid's
tax sharing arrangement, a subsidiary will only receive a benefit for a net
operating loss carryforward to the extent it can be utilized in Rite Aid's
consolidated tax filing.
The Company's income tax expense has been computed as if the Company filed
separate income tax returns for all periods. However, due to the tax sharing
arrangement with Rite Aid, the Company is unable to use any of its net operating
loss carryforwards for the year ending February 26, 2000. Instead, the Company
is utilizing current year losses generated by Rite Aid and, therefore, must
compensate Rite Aid for the use of these losses.
11
<PAGE> 14
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
5. INCOME TAXES (CONTINUED)
Following is the composition of income tax expense:
<TABLE>
<CAPTION>
THIRTY-SIX
DAYS ENDED YEAR ENDED
FEBRUARY 27, FEBRUARY 26,
1999 2000
------------ ------------
<S> <C> <C>
Current:
Federal $ 9,993 $ 25,922
State -- 7,102
------------ ------------
9,993 33,024
Deferred:
Federal (7,814) 3,538
State 722 974
------------ ------------
(7,092) 4,512
------------ ------------
$ 2,901 $ 37,536
============ ============
</TABLE>
Income tax expense differs from the amount computed by applying the federal
statutory rate to the income before income taxes as follows:
<TABLE>
<CAPTION>
THIRTY-SIX
DAYS ENDED YEAR ENDED
FEBRUARY 27, FEBRUARY 26,
1999 2000
------------ ------------
<S> <C> <C>
Income tax expense computed at federal statutory
rate $ 1,164 $ 20,661
State income taxes, net of federal benefit 469 5,249
Amortization of goodwill 1,110 11,223
Other, net 158 403
------------ ------------
$ 2,901 $ 37,536
============ ============
</TABLE>
12
<PAGE> 15
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
5. INCOME TAXES (CONTINUED)
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred income tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
FEBRUARY 27, FEBRUARY 26,
1999 2000
------------ ------------
<S> <C> <C>
Current deferred income tax assets (liabilities):
Risk reserves $ 7,134 $ 5,804
Allowances 7,283 5,980
Deferred revenue (6,722) (12,852)
Deferred compensation 908 1,073
Other 1,553 41
------------ ------------
Net current deferred income tax assets $ 10,156 $ 46
============ ============
Long-term deferred income tax assets (liabilities):
Postemployment plan $ 1,991 $ 2,956
Deferred compensation 4,483 4,572
Net operating loss carryforwards 19,540 19,540
Other intangible assets (236,045) (226,343)
Capitalized software (11,174) (16,935)
Accelerated depreciation (6,148) (6,843)
Other 280 1,582
Valuation allowance (11,054) (11,054)
------------ ------------
Net long-term deferred income tax liabilities $ (238,127) $ (232,525)
============ ============
</TABLE>
At February 26, 2000, the Company has federal net operating loss carryforwards
of approximately $51,779 which begin to expire in the year 2018. The utilization
of these net operating losses could be limited by specific sections of the
Internal Revenue Code related to stock ownership changes. The Company has a
valuation allowance at February 27, 1999 and February 26, 2000 as it is
uncertain, at present, that it will realize the full benefit of the net
operating loss carryforwards under Rite Aid's tax sharing arrangement. A
valuation allowance has not been established for a portion of the net operating
loss carryforwards as it relates to a liability associated with a tax benefit
due to Lilly upon being recognized.
13
<PAGE> 16
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
6. OTHER CURRENT LIABILITIES
Other current liabilities consist of the following:
<TABLE>
<CAPTION>
FEBRUARY 27, FEBRUARY 26,
1999 2000
------------ ------------
<S> <C> <C>
Accounts payable and accrued expenses $ 52,452 $ 95,764
Employee compensation 12,635 23,407
Deposits 14,713 12,894
Unearned revenue 6,118 22,612
Other 40,963 30,731
------------ ------------
$ 126,881 $ 185,408
============ ============
</TABLE>
7. LEASES
Future minimum operating lease payments for facilities and equipment at February
26, 2000 are as follows:
<TABLE>
<S> <C>
Fiscal years ended:
2001 $ 11,672
2002 9,184
2003 5,363
2004 1,334
2005 555
Thereafter 593
---------
$ 28,701
=========
</TABLE>
Rent expense was $1,343 during the thirty-six days ended February 27, 1999 and
$17,045 during the year ended February 26, 2000.
8. COMMITMENTS AND CONTINGENCIES
The Company enters into risk contracts with certain customers in the ordinary
course of business. These contracts provide that the Company assume varying
percentages of the risk associated with claims experience differing from fixed
fee arrangements under managed care programs. In addition, the Company, in
certain limited circumstances, guarantees a specific amount of savings for
certain customers. Included in other current liabilities in the accompanying
consolidated balance sheets are management's estimates of the amounts required
to cover losses incurred under such contracts.
14
<PAGE> 17
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
8. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company is subject to various claims, including possible legal actions
brought by plan sponsors for alleged errors or omissions arising out of the
ordinary course of business. Management believes that it has a combination of
adequate insurance coverage and reserves against potential losses and that the
outcome of such claims will not have a material adverse effect on the Company's
consolidated financial position or results of operations.
9. RETIREMENT BENEFITS
The funded status and amounts recognized in the consolidated balance sheets at
February 27, 1999 and February 26, 2000 for the Company's defined benefit
pension and retiree health benefit plans, as well as changes in the benefit
obligation and plan assets during fiscal 2000, were as follows:
<TABLE>
<CAPTION>
DEFINED BENEFIT RETIREE
PENSION PLAN HEALTH BENEFITS
--------------- ---------------
<S> <C> <C>
Change in benefit obligation:
Benefit obligation at February 27, 1999 $ 23,271 $ 3,756
Service cost 3,740 693
Interest cost 1,567 252
Actuarial gain (4,158) (706)
Benefits paid (187) (66)
------------ ------------
Benefit obligation at February 26, 2000 24,233 3,929
Change in plan assets:
Fair value of plan assets at February 27, 1999 21,680 --
Actual return on plan assets 3,595 --
Employer contribution 2,380 66
Benefits paid (187) (66)
------------ ------------
Fair value of plan assets at February 26, 2000 27,468 --
Funded status 3,235 (3,929)
Unrecognized net actuarial gain (5,509) (383)
------------ ------------
Net amount recognized $ (2,274) $ (4,312)
============ ============
Amounts recognized in consolidated balance sheet consisted of:
Accrued benefit liability $ 2,274 $ 4,312
------------ ------------
Net amount recognized $ 2,274 $ 4,312
============ ============
Weighted-average assumptions as of February 26, 2000:
Discount rate 7.8% 7.8%
Expected return on plan assets 9.0 --
Rate of compensation increase 5.9 --
</TABLE>
15
<PAGE> 18
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
9. RETIREMENT BENEFITS (CONTINUED)
Health care cost trend rates were assumed to increase at an annual rate of 6.5
percent in 2001 for participants under age 65, and decrease one-half percent per
year to 5.5 percent in 2002 and thereafter. For participants over age 65, the
annual rate was assumed to be 5.5 percent.
Net pension and retiree health benefit expense were not computed for the
thirty-six days ended February 27, 1999. The amounts for the year ended February
26, 2000 included the following components:
<TABLE>
<CAPTION>
DEFINED BENEFIT RETIREE
PENSION PLAN HEALTH BENEFITS
--------------- ---------------
<S> <C> <C>
Components of net periodic benefit cost:
Service cost $ 3,740 $ 693
Interest cost 1,567 252
Expected return on plan assets (1,873) --
------------ ------------
Net periodic benefit cost $ 3,434 $ 945
============ ============
</TABLE>
The assumed health care cost trend rates have a significant effect on the
retiree health benefits amounts reported. If these trend rates were to be
increased by one percentage point each future year, the February 26, 2000
accumulated postretirement benefit obligation would increase by 13.4 percent,
and the aggregate of the service cost and interest cost components of 2000
annual expense would increase by 17.6 percent. A one percentage point decrease
in these rates would decrease the February 26, 2000 accumulated postretirement
benefit obligation by 11.7 percent, and the aggregate of the 1999 service cost
and interest cost by 14.9 percent.
The Company also has a defined contribution savings plan that covers its
eligible employees. The purpose of the defined contribution plan is generally to
provide additional financial security during retirement by providing employees
with an incentive to make regular savings. Company contributions to the plan are
based on employee contributions and the level of Company match. Expenses under
the plan totaled $439 during the thirty-six days ended February 27, 1999 and
$5,440 during the year ended February 26, 2000.
The Company provides certain other postemployment benefits, primarily related to
disability benefits, and accrues for the related cost over the service lives of
the employees. Expenses associated with these benefit plans during the years
ended February 27, 1999 and February 26, 2000 were not significant.
16
<PAGE> 19
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
10. RELATED PARTY TRANSACTIONS
Officer Retention Bonuses
At the time Rite Aid purchased the Company, certain of the Company's officers
were provided with a financial incentive to remain at the Company. Under this
retention incentive program, and by remaining at the Company, the participating
officers vest annually in the financial benefits through January 22, 2002. The
value of the benefits is determined based upon the Rite Aid stock price during
the vesting period, but is not to be less than an established floor value. The
Company recognized compensation expense under this program of $706 during the
thirty-six days ended February 27, 1999 and $7,137 during the year ended
February 26, 2000.
In the event of a change in control of the Company, the participating officers
immediately become fully vested in the program's benefits. The occurrence of
such an event at February 26, 2000 would have caused approximately $5,178 of
additional compensation costs to be recognized during the year ended February
26, 2000.
Other
Certain expenses, principally employee benefits and general liability and
workers' compensation insurance premiums, are paid on behalf of and charged to
the Company by Rite Aid. In addition, the Company has used certain resources and
administrative staff of Rite Aid, including financial, legal, tax, internal
audit, accounting advice, and other personnel and employee benefit services.
Management believes that the consolidated statements of operations include an
appropriate allocation of all material costs incurred by Rite Aid during
thirty-six days ended February 27, 1999 and the year ended February 26, 2000 on
the Company's behalf.
The Company has not recognized any revenue in connection with transactions with
Rite Aid during the thirty-six days ended February 27, 1999 or the year ended
February 26, 2000.
Rite Aid employees have received health insurance coverage from some of the
Company's health plan customers. The impact of this on the Company's revenue is
not material to the consolidated financial statements.
The Company recognized net interest income under its cash management programs
with Rite Aid of $0 during the thirty-six days ended February 27, 1999 and
$7,875 during the year ended February 26, 2000.
17
<PAGE> 20
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
11. YEAR 2000 (UNAUDITED)
The Company was required to modify or replace certain portions of its software,
hardware and equipment so that its systems and equipment would function properly
with respect to dates in the year 2000 and thereafter. The Company utilized both
internal and external resources to reprogram or replace, and test the software
and equipment for year 2000 readiness. The majority of the Company's business is
performed with third parties via interfaced systems. As a result, the Company's
Year 2000 project included a review of the third parties to determine the extent
the Company would be affected by third party failures to mitigate their own Year
2000 issues.
For its assessment and efforts on its Year 2000 project, the Company incurred
approximately $10.4 million ($10.1 million expensed and $.3 million capitalized
for new systems and equipment) through February 27, 1999, and $12.9 million
($12.6 million expensed and $.3 million capitalized for new systems and
equipment) through February 26, 2000.
12. SUBSEQUENT EVENTS
Rite Aid has entered into an agreement with an outside party to sell certain of
the Company's real property assets with a book value at February 26, 2000 of
approximately $17,995 (primarily including 53.4 acres of land located in
Scottsdale, Arizona). It is planned that, subsequent to February 26, 2000, the
Company will transfer these real property assets to Rite Aid.
In June 2000, Rite Aid entered into a new senior credit facility agreement with
an outside lender under which all of the assets of the Company are pledged as
security.
18
<PAGE> 21
Consolidated Financial Statements
PCS HOLDING CORPORATION
AND SUBSIDIARIES
December 31, 1998
<PAGE> 22
PCS Holding Corporation and Subsidiaries
Consolidated Financial Statements
As of December 31, 1997 and 1998 and for the
Years Ended December 31, 1996, 1997 and 1998
CONTENTS
<TABLE>
<S> <C>
Report of Independent Auditors................................................1
Consolidated Financial Statements
Consolidated Balance Sheets...................................................2
Consolidated Statements of Operations.........................................3
Consolidated Statements of Shareholders' Equity...............................4
Consolidated Statements of Cash Flows.........................................5
Notes to Consolidated Financial Statements....................................6
</TABLE>
<PAGE> 23
Report of Independent Auditors
Shareholders
PCS Holding Corporation and Subsidiaries
We have audited the accompanying consolidated balance sheets of PCS Holding
Corporation and Subsidiaries (the Company) as of December 31, 1997 and 1998, and
the related consolidated statements of operations, shareholders' equity, and
cash flows for each of the three years in the period ended December 31, 1998.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of PCS
Holding Corporation and Subsidiaries at December 31, 1997 and 1998, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles.
/s/ ERNST & YOUNG LLP
January 14, 1999
1
<PAGE> 24
PCS Holding Corporation and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands, except par values)
<TABLE>
<CAPTION>
DECEMBER 31
1997 1998
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 2,157 $ 2,956
Accounts receivable, less allowances of $12,995 in 1997 and
$10,174 in 1998 374,853 492,416
Due from Parent 158,948 256,446
Other receivables 1,225 650
Inventories 12,146 16,673
Prepaid expenses 1,948 2,050
Deferred income taxes 16,570 13,965
----------- -----------
Total current assets 567,847 785,156
Goodwill, net of amortization of $279,170 in 1997 and
$318,102 in 1998 1,436,289 1,397,357
Property and equipment, net 96,200 105,038
Deferred income taxes 2,896 --
----------- -----------
Total assets $ 2,103,232 $ 2,287,551
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Claims and rebates payable $ 354,341 $ 435,196
Checks outstanding in excess of bank balances 234,131 317,851
Deposits 22,713 20,125
Other 103,550 113,118
----------- -----------
Total current liabilities 714,735 886,290
Noncurrent liabilities:
Deferred income taxes -- 5,863
Other liabilities 14,163 13,061
Shareholders' equity:
Class A voting common stock, $1 par value; 1,000 shares authorized;
565 shares outstanding at December 31, 1997 and 1998 1 1
Class B voting convertible preferred stock, $1 par value; 160 and 0 shares
authorized and outstanding at December 31, 1997 and 1998, respectively
----------- -----------
Additional paid-in capital 3,953,036 3,957,368
Accumulated deficit (2,578,703) (2,575,032)
----------- -----------
Total shareholders' equity 1,374,334 1,382,337
----------- -----------
Total liabilities and shareholders' equity $ 2,103,232 $ 2,287,551
=========== ===========
</TABLE>
See accompanying notes.
2
<PAGE> 25
PCS Holding Corporation and Subsidiaries
Consolidated Statements of Operations
(Dollars in thousands)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
REVENUE
Claims processing $ 146,929 $ 171,371 $ 141,096
Manufacturer programs 63,666 119,289 183,758
Mail order programs 111,090 224,094 467,202
Other 32,814 32,671 48,648
----------- ----------- -----------
354,499 547,425 840,704
EXPENSES
Cost of goods and services 248,015 428,705 660,305
Selling, general and administrative 103,822 98,972 95,293
Goodwill amortization 101,518 65,010 38,933
Asset impairment -- 2,345,244 --
Interest, net 1,164 (1,202) (2,417)
----------- ----------- -----------
454,519 2,936,729 792,114
----------- ----------- -----------
(Loss) income before income taxes (100,020) (2,389,304) 48,590
Income tax expense 6,213 6,264 31,956
----------- ----------- -----------
Net (loss) income $ (106,233) $(2,395,568) $ 16,634
=========== =========== ===========
</TABLE>
See accompanying notes.
3
<PAGE> 26
PCS Holding Corporation and Subsidiaries
Consolidated Statements of Shareholders' Equity
Years Ended December 31
(Dollars in thousands)
<TABLE>
<CAPTION>
COMMON STOCK CLASS A STOCK CLASS B STOCK
---------------------- --------------------- ---------------------- ADDITIONAL
NUMBER OF PAR NUMBER OF PAR NUMBER OF PAR PAID-IN
SHARES VALUE SHARES VALUE SHARES VALUE CAPITAL
----------- ------- ----------- ------- ----------- ------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1996 100 $ -- -- $ -- -- $ -- $ 3,953,037
Net loss -- -- -- -- -- -- --
----------- ------- ----------- ------- ----------- ------- -----------
Balance at December 31, 1996 100 -- -- -- -- -- 3,953,037
Net loss -- -- -- -- -- -- --
Recapitalization, on October 7, 1997 (100) -- 565 1 160 -- (1)
Dividends to Class B shareholder -- -- -- -- -- -- --
----------- ------- ----------- ------- ----------- ------- -----------
Balance at December 31, 1997 -- -- 565 1 160 -- 3,953,036
Net income -- -- -- -- -- -- --
Capital contribution from Parent -- -- -- -- -- -- 177,120
Dividends to Class B shareholder -- -- -- -- -- -- --
Repurchase of Class B shares -- -- -- -- (160) -- (172,660)
Other equity transfers -- -- -- -- -- -- (128)
----------- ------- ----------- ------- ----------- ------- -----------
Balance at December 31, 1998 -- $ -- 565 $ 1 -- $ -- $ 3,957,368
=========== ======= =========== ======= =========== ======= ===========
<CAPTION>
ACCUMULATED
DEFICIT TOTAL
------------ -----------
<S> <C> <C>
Balance at January 1, 1996 $ (74,847) $ 3,878,190
Net loss (106,233) (106,233)
----------- -----------
Balance at December 31, 1996 (181,080) 3,771,957
Net loss (2,395,568) (2,395,568)
Recapitalization, on October 7, 1997 -- --
Dividends to Class B shareholder (2,055) (2,055)
----------- -----------
Balance at December 31, 1997 (2,578,703) 1,374,334
Net income 16,634 16,634
Capital contribution from Parent -- 177,120
Dividends to Class B shareholder (12,963) (12,963)
Repurchase of Class B shares -- (172,660)
Other equity transfers -- (128)
----------- -----------
Balance at December 31, 1998 $(2,575,032) $ 1,382,337
=========== ===========
</TABLE>
See accompanying notes.
4
<PAGE> 27
PCS Holding Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars in thousands)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net (loss) income $ (106,233) $(2,395,568) $ 16,634
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Depreciation and amortization 118,163 82,694 55,351
Loss on asset disposal -- -- 2,967
Asset impairment -- 2,345,244 --
Provision for losses on receivables and other allowances
13,525 12,091 1,265
Deferred income tax expense 8,558 5,703 11,364
Changes in operating assets and liabilities:
Receivables 117,619 (9,236) (110,800)
Inventories (3,649) (7,468) (4,527)
Prepaid expenses 410 353 (102)
Claims and rebates payable (56,002) 12,789 80,855
Checks outstanding in excess of bank balances (93,356) 60,712 83,720
Accrued and other liabilities (4,946) 14,840 (1,575)
----------- ----------- -----------
Net cash (used in) provided by operating activities (5,911) 122,154 135,152
INVESTING ACTIVITIES
Additions to property and equipment (30,599) (15,490) (28,224)
----------- ----------- -----------
Net cash used in investing activities (30,599) (15,490) (28,224)
FINANCING ACTIVITIES
Change in due from Parent 36,061 (104,477) (97,498)
Dividends to Class B shareholder -- (2,055) (12,963)
Capital contribution from Parent -- -- 177,120
Repurchase of Class B shares -- -- (172,660)
Other equity transfers -- -- (128)
----------- ----------- -----------
Net cash provided by (used in) financing activities 36,061 (106,532) (106,129)
----------- ----------- -----------
Net (decrease) increase in cash (449) 132 799
Cash at beginning of year 2,474 2,025 2,157
----------- ----------- -----------
Cash at end of year $ 2,025 $ 2,157 $ 2,956
=========== =========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest $ 363 $ 566 $ 622
=========== =========== ===========
Cash paid for income taxes $ 645 $ 1,706 $ 19,366
=========== =========== ===========
</TABLE>
See accompanying notes.
5
<PAGE> 28
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
1. DESCRIPTION OF BUSINESS
PCS Holding Corporation and Subsidiaries (the "Company") is an
information-driven health solutions company operating in the United States. The
Company provides managed pharmaceutical-related programs and services that can
directly and positively improve the health of patients, and help reduce health
care costs.
On November 21, 1994, the Company was acquired by Eli Lilly and Company (the
"Parent") for approximately $4.1 billion. The acquisition was accounted for as a
purchase by its Parent, and the resulting goodwill was pushed down to the
Company's consolidated balance sheet (see Asset Impairment note). In November
1998, the Parent entered into an agreement with Rite Aid Corporation (Rite Aid)
whereby Rite Aid will purchase all outstanding shares of the Company's stock
(see Sale of the Company note).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements of the Company include PCS
Holding Corporation and its wholly owned subsidiaries. All material intercompany
balances and trans-actions have been eliminated in consolidation.
Management believes that the consolidated statements of operations include an
appropriate allocation of all material costs incurred by the Parent on the
Company's behalf.
Reclassifications
Certain reclassifications have been made to the 1996 and 1997 consolidated
financial statements to conform with the classifications of the 1998
consolidated financial statements.
Use of Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets, liabilities,
revenues, expenses and related disclosures at the date of the consolidated
financial statements and during the reporting period. Actual results could
differ from those estimates.
6
<PAGE> 29
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
New Financial Accounting Standard
In December 1997, Statement of Financial Accounting Standard (SFAS) No. 132,
Employers' Disclosures about Pensions and Other Postretirement Benefits, was
issued and, as required, was adopted by the Company in 1998. The statement
revises current disclosure requirements for employers' pensions and other
retiree benefits. Implementation of this disclosure standard did not affect the
Company's consolidated financial position or results of operations.
Concentrations of Credit Risk
Financial instruments that subject the Company to credit risk consist
principally of (i) claims reimbursement receivables and claim fees receivable
and (ii) the Company's portion of manufacturer program receivables. The Company
monitors the credit worthiness of the customers to which it grants credit terms
in the normal course of business and takes deposits from customers when
considered necessary to collateralize its position. Concentrations of credit
risk associated with these trade receivables are considered minimal due to a
diverse, geographically dispersed customer base.
Manufacturer program receivables (included in accounts receivable) are
concentrated in the drug manufacturing industry and had a net balance of $55,053
in 1997 and $78,455 in 1998.
Cash and Cash Equivalents
Cash and cash equivalents include all highly liquid financial instruments
purchased with a maturity of three months or less, and the carrying value
approximates fair value.
Accounts Receivable and Claims and Rebates Payable
Accounts receivable consists primarily of claims reimbursement receivables,
claims processing fees receivable and manufacturer program receivables. Because
these items are short-term in nature, their carrying amounts approximate fair
value.
Claims reimbursement receivables and claims payables arise from the adjudication
of pharmacy claims. These amounts, along with the related claims processing fees
receivable, are recorded when a reimbursement request is received by the
Company. Reimbursements for claim payments are not included in revenues, and
payments to member pharmacies are not included in expenses. Checks outstanding
are classified as liabilities because they are drawn on zero balance accounts.
7
<PAGE> 30
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Manufacturers' rebates receivable and rebates payable arise from manufacturers'
rebate programs and are recorded when a claim eligible for rebate is processed
by the Company. Rebates are paid to customers upon collection from manufacturers
and are either contractually limited to actual collections from manufacturers or
are guaranteed for a certain rebate per claim. Liabilities associated with the
guarantees per claim are included in other liabilities. The Company generally
retains a portion of rebates collected as a processing fee. The remainder of
rebates collected is not included in revenues, and payments of rebates to
customers are not included in expenses.
Due from Parent
The Company participates in the daily cash management program of its Parent
through which it invests excess cash and has access to short-term borrowings.
The Company pays or receives interest on its balances in the program at the per
annum interest rate of 90-day dealer placed commercial paper.
Inventories
Inventories consist primarily of pharmaceutical products for mail order
programs. Inventories are recorded at the lower of cost or market. Cost is
determined using the first-in, first-out method.
Deferred Income Taxes
Deferred income taxes are recognized for the future tax effects of temporary
differences between financial and income tax reporting based on enacted tax laws
and rates.
Goodwill
Goodwill represents the amount of the purchase price paid in excess of the net
tangible assets acquired and is being amortized on a straight-line basis over 40
years. On a periodic basis, the Company estimates the future undiscounted cash
flows of its business to which goodwill relates to assure that the carrying
value of goodwill has not been impaired (see Asset Impairment note).
8
<PAGE> 31
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Property and Equipment
Property and equipment is stated at cost, less accumulated depreciation.
Provisions for depreciation are generally computed by the straight-line method
at rates based on the estimated useful lives of the underlying assets as
follows:
<TABLE>
<S> <C>
Buildings and improvements 5 to 20 years
Equipment 3 to 5 years
Furniture and fixtures 10 years
Capitalized software 2 to 8 years
</TABLE>
When property or equipment is retired or sold, its cost and related accumulated
depreciation are written off and the resulting gain or loss is included in net
earnings.
Revenues
Revenues include claims processing fees which are accrued when the related claim
is processed and approved for payment. Certain of the Company's agreements
require its customers to pay a fee per covered member rather than a fee per
claim processed. The Company records these fees monthly based upon member counts
provided by its customers. Revenues from manufacturer programs are recognized
when services are performed. Mail order program revenue is recognized when
prescriptions are shipped. Other revenues are generally recognized as the
related services are performed.
Total revenue from unaffiliated customers, all of which are generated in the
United States, were approximately $347,000 in 1996, $527,000 in 1997 and
$810,000 in 1998.
3. SALE OF THE COMPANY
In November 1998, the Parent entered into an agreement with Rite Aid whereby
Rite Aid will purchase from the Parent all shares of the Company's Class A stock
for approximately $1.5 billion, with the Parent retaining $100 million of
additional cash. In connection with this transaction, the Company bought back
all outstanding Class B shares for $172,660. In addition to dividends paid for
first three quarters of 1998 of $7,292, Class B dividends of $5,671 were paid at
the time of the buy back of the Class B shares. The buy back of the Class B
shares and the payment of the dividends were primarily funded by a $177,120
capital contribution from the Parent.
9
<PAGE> 32
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
3. SALE OF THE COMPANY (CONTINUED)
The terms of the sale agreement support the future benefit of the Company's
carrying value of goodwill and net deferred tax assets. The Company is not aware
of any plans or intentions, in connection with the proposed sale, to terminate
any of the Company's pension or other postretirement employee benefit plans.
4. ASSET IMPAIRMENT
The Parent purchased the Company for approximately $4.1 billion in November
1994. Substantially all of the purchase price was allocated to goodwill.
During 1997, pursuant to SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, the Parent
evaluated the recoverability of long-lived assets, including intangibles, of the
Company's health-care-management businesses. While revenues and profits had
grown since acquisition and new capabilities were being developed at the
Company, the rapidly changing, competitive and highly regulated environment in
which the Company operates had prevented the Company from significantly
increasing its operating profits from levels that existed prior to the
acquisition. In addition, since the acquisition, the healthcare-industry trend
toward increased managed care had been slower than originally expected and the
possibility of selling a portion of the Company's equity to a strategic partner
had not been realized. In the second quarter of 1997, concurrent with the
Company's annual planning process, the Parent determined that the Company's
estimated future undiscounted cash flows were below the carrying value of the
Company's long-lived assets. Accordingly, the carrying value of the Company's
long-lived assets, primarily goodwill, was adjusted to their estimated fair
value of approximately $1.5 billion, resulting in a noncash impairment loss of
approximately $2.3 billion during 1997. The estimated fair value was based on
anticipated future cash flows discounted at a rate commensurate with the risk
involved.
10
<PAGE> 33
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
5. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Land $ 29,329 $ 29,329
Buildings and improvements 31,905 37,592
Equipment 86,362 79,036
Furniture and fixtures 14,689 15,219
Capitalized software 21,391 43,901
Construction in progress 4,077 4,248
--------- ---------
187,753 209,325
Accumulated depreciation (91,553) (104,287)
--------- ---------
$ 96,200 $ 105,038
========= =========
</TABLE>
Depreciation expense during was $16,645 in 1996, $17,692 in 1997 and $16,414 in
1998.
6. INCOME TAXES
The Company was included in its Parent's consolidated federal income tax returns
for periods from January 1, 1995 through October 15, 1997. For the period from
October 16, 1997 through December 31, 1997, and for the twelve month period
ended December 31, 1998, the Company filed its own separate federal tax returns
(see Stockholders' Equity note). The Company's income tax expense has been
computed as if the Company filed separate income tax returns for all years.
Following is the composition of income tax expense for the years ended
December 31:
<TABLE>
<CAPTION>
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Current:
Federal $ (3,498) $ (400) $ 20,101
State 1,153 961 491
-------- -------- --------
(2,345) 561 20,592
Deferred:
Federal 1,523 5,440 11,944
State 7,035 263 (580)
-------- -------- --------
8,558 5,703 11,364
-------- -------- --------
$ 6,213 $ 6,264 $ 31,956
======== ======== ========
</TABLE>
11
<PAGE> 34
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
6. INCOME TAXES (CONTINUED)
Income tax expense differs from the amount computed by applying the federal
statutory rate to the (loss) income before income taxes for the years ended
December 31 as follows:
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Income tax benefit computed at federal statutory rate $ (35,007) $(836,975) $ 12,469
State income taxes, net of federal benefit 5,342 385 319
Amortization of goodwill 35,531 22,754 13,626
Asset impairment -- 820,835 --
Dividends paid to minority owner -- -- 4,537
Other, net 347 (735) 1,005
--------- --------- ---------
$ 6,213 $ 6,264 $ 31,956
========= ========= =========
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred income tax assets and liabilities at December 31 are as
follows:
<TABLE>
<CAPTION>
1997 1998
------- -------
<S> <C> <C>
Current deferred income tax assets:
Risk reserves $12,614 $ 8,823
Allowances 3,634 4,831
Deferred compensation 136 --
Other 186 311
------- -------
Net current deferred income tax assets $16,570 $13,965
======= =======
Long-term deferred income tax assets (liabilities):
Risk reserves $ 206 $ --
Postretirement plan 1,894 1,484
Deferred compensation 2,747 3,845
Net operating loss carryforward 1,360 --
Capitalized software (1,136) (8,532)
Accelerated depreciation (4,324) (3,129)
Other 2,149 469
------- -------
Net long-term deferred income tax assets (liabilities) $ 2,896 $(5,863)
======= =======
</TABLE>
The benefit of the Company's federal net operating loss carryforward for the
period ended December 31, 1997 is expected to be realized in connection with the
filing of the 1998 federal tax return.
12
<PAGE> 35
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
7. OTHER CURRENT LIABILITIES
Other current liabilities consist of the following at December 31:
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Accounts payable $ 31,778 $ 29,763
Employee compensation 24,905 39,500
Other 46,867 43,855
-------- --------
$103,550 $113,118
======== ========
</TABLE>
8. LEASES
Future minimum operating lease payments for facilities and equipment at
December 31, 1998 are as follows:
<TABLE>
<S> <C>
1999 $ 8,264
2000 4,203
2001 3,545
2002 2,922
2003 1,236
Thereafter 635
-------
$20,805
=======
</TABLE>
Rent expense was $12,556 in 1996, $14,287 in 1997 and $17,059 in 1998,
respectively.
9. COMMITMENTS AND CONTINGENCIES
The Company enters into risk contracts with certain customers in the ordinary
course of business. These contracts provide that the Company assume varying
percentages of the risk associated with claims experience differing from fixed
fee arrangements under managed care programs. In addition, the Company
guarantees a specific amount of savings for certain customers. Included in other
liabilities in the accompanying consolidated balance sheets are management's
estimates of the amounts required to cover losses incurred under such contracts.
The Company is subject to various claims, including possible legal actions
brought by plan sponsors for alleged errors or omissions arising out of the
ordinary course of business. Management believes that it has a combination of
adequate insurance coverage and reserves against potential losses and that the
outcome of such claims will not have a material adverse effect on the Company's
consolidated financial position or results of operations.
13
<PAGE> 36
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
10. SHAREHOLDERS' EQUITY
At January 1, 1996, the Company's capital structure included one cent par value
preferred stock; 10,000,000 shares authorized; no shares outstanding, and one
cent par value common stock; 1,000 shares authorized; 100 shares outstanding.
On October 7, 1997, the Certificate of Incorporation for PCS Holding Corporation
was restated. Upon filing the Restated Certificate of Incorporation, the shares
of Common Stock of PCS Holding Corporation then outstanding were recapitalized
into the aggregate of 565 shares of Class A voting common stock and 160 shares
of Class B voting convertible preferred stock of PCS Holding Corporation. Under
the Restated Certificate of Incorporation, the Company has authority to issue
1,000 shares of Class A stock, 160 shares of Class B Stock, and 1,000 shares of
Class C Stock, par value of one dollar per share, issuable in series.
In connection with the recapitalization in 1997, the Company issued the 565
shares of Class A stock and 160 shares of Class B stock to the Parent, who then
sold the Class B stock to an institutional investor. During 1998, the Company
bought back all outstanding Class B shares (see sale of the Company note). The
Class B stock was convertible preferred stock and paid dividends on a quarterly
basis at 25 basis points above the three-month LIBOR rate. The Class B stock was
convertible on a one-to-one basis into the Company's Class A stock at the option
of the holder at any time.
No shares of Class C stock have been issued or are outstanding.
14
<PAGE> 37
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
11. RETIREMENT BENEFITS
The funded status and amounts recognized in the consolidated balance sheets at
December 31, 1997 and 1998 for the Company's defined benefit pension and retiree
health benefit plans, as well as changes in the benefit obligation and plan
assets during those years, were as follows:
<TABLE>
<CAPTION>
1997 1998
----------------------------------- ---------------------------------
DEFINED BENEFIT RETIREE DEFINED BENEFIT RETIREE
PENSION PLAN HEALTH BENEFITS PENSION PLAN HEALTH BENEFITS
----------------------------------- ----------------------------------
<S> <C> <C> <C> <C>
Change in benefit obligation:
Benefit obligation at beginning of $ 12,397 $ 1,411 $ 21,969 $ 2,018
year
Service cost` 2,843 344 2,623 519
Interest cost 991 113 1,647 150
Actuarial loss (gain) 5,760 150 (5,039) 538
Benefits paid (22) -- (79) (51)
-------- -------- -------- --------
Benefit obligation at end of year 21,969 2,018 21,121 3,174
Change in plan assets:
Fair value of plan assets at
beginning of year 8,861 -- 13,978 --
Actual return on plan assets 1,452 -- 1,365 --
Employer contribution 3,687 -- 5,154 51
Benefits paid (22) -- (79) (51)
-------- -------- -------- --------
Fair value of plan assets at end of year 13,978 -- 20,418 --
Funded status (7,991) (2,018) (703) (3,174)
Unrecognized net actuarial loss 4,886 53 3 591
Unrecognized prior service cost -- 139 -- 93
-------- -------- -------- --------
Net amount recognized $ (3,105) $ (1,826) $ 700 $ 2,490
======== ======== ======== ========
Amounts recognized in consolidated
balance sheet consisted of:
Prepaid benefit cost $ -- $ -- $ -- $ --
Accrued benefit liability (3,105) (1,826) (700) (2,490)
Accumulated other comprehensive
income, before income taxes -- -- -- --
-------- -------- -------- --------
Net amount recognized $ (3,105) $ (1,826) $ (700) $ (2,490)
======== ======== ======== ========
Weighted-average assumptions as of
December 31:
Discount rate 7.5% - 7.5% -
Expected return on plan assets 10.5 - 10.5 -
Rate of compensation increase 4.0 to 8.0 - 5.9 -
</TABLE>
15
<PAGE> 38
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
11. RETIREMENT BENEFITS (CONTINUED)
Health care cost trend rates were assumed to increase at an annual rate of 6.5
percent in 1999 for participants under age 65, and decrease one-half percent per
year to 5.0 percent in 2002 and thereafter. For participants over age 65, the
rate was assumed to increase 5.0 percent in 1999 and thereafter.
Net pension and retiree health benefit expense for the years ended December 31,
1996, 1997 and 1998 included the following components:
<TABLE>
<CAPTION>
DEFINED BENEFIT PENSION PLAN RETIREE HEALTH BENEFITS
------------------------------- ---------------------------
1996 1997 1998 1996 1997 1998
------------------------------- ---------------------------
<S> <C> <C> <C> <C> <C> <C>
Components of net periodic benefit cost:
Service cost $ 2,497 $ 2,843 $ 2,623 $ 292 $ 344 $ 519
Interest cost 837 991 1,647 85 113 150
Expected return on plan assets (577) (971) (1,700) -- -- --
Amortization of prior service cost
and net obligation at January 1, 1986 -- -- -- 46 46 46
Recognized actuarial loss 58 -- 179 -- -- --
------- ------- ------- ------- ------- -------
Net periodic benefit cost $ 2,815 $ 2,863 $ 2,749 $ 423 $ 503 $ 715
======= ======= ======= ======= ======= =======
</TABLE>
The assumed health care cost trend rates have a significant effect on the
retiree health benefits amounts reported. If these trend rates were to be
increased by one percentage point each future year, the December 31, 1998
accumulated postretirement benefit obligation would increase by 15 percent, and
the aggregate of the service cost and interest cost components of 1998 annual
expense would increase by 18 percent. A one percentage point decrease in these
rates would decrease the December 31, 1998, accumulated postretirement benefit
obligation by 13 percent, and the aggregate of the 1998 service cost and
interest cost by 15 percent.
The Company also has a defined contribution savings plan that covers its
eligible employees. The purpose of the defined contribution plan is generally to
provide additional financial security during retirement by providing employees
with an incentive to make regular savings. Company contributions to the plan are
based on employee contributions and the level of Company match. Expenses under
the plan totaled $3,019 in 1996, $3,352 in 1997 and $4,483 in 1998.
The Company provides certain other postemployment benefits, primarily related to
disability benefits, and accrues for the related cost over the service lives of
the employees. Expenses associated with these benefit plans during the years
ended December 31, 1996, 1997 and 1998 were not significant.
16
<PAGE> 39
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
12. RELATED PARTY TRANSACTIONS
Certain expenses, principally employee benefits and general liability and
workers' compensation insurance premiums, are paid on behalf of and charged to
the Company by the Parent. In addition, the Company uses certain resources and
administrative staff of its Parent, including financial, legal, tax, internal
audit, accounting advice, and other personnel and employee benefit services.
Management believes that the consolidated statements of operations include an
appropriate allocation of all material costs incurred by the Parent on the
Company's behalf.
Certain of the Company's employees are periodically granted options by the
Parent to purchase the Parent's stock. The exercise price of these options is
equal to the market value of the stock at the date of grant.
The Company additionally recognized the following transactions with the Parent
in its consolidated statements of operations:
<TABLE>
<CAPTION>
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Revenue:
Administration fee revenue $ 825 $ 3,147 $ 4,296
Outcomes research revenue 3,500 3,720 3,500
RxReview revenue 2,700 8,100 7,052
Clinical consulting -- 1,760 14,152
Other -- 3,900 1,500
------- ------- -------
Total revenue $ 7,025 $20,627 $30,500
======= ======= =======
</TABLE>
13. IMPACT OF YEAR 2000 (UNAUDITED)
The Company has determined that it will be required to modify or replace certain
portions of its software, hardware and equipment so that its systems and
equipment will function properly with respect to dates in the year 2000 and
thereafter. The Company is utilizing both internal and external resources to
reprogram, or replace, and test the software and equipment for year 2000
readiness. The majority of the Company's business is performed with third
parties via interfaced systems. As a result, the Company's Year 2000 project
includes a review of the third parties to determine the extent the company will
be affected by third party failures to mitigate their own Year 2000 issues.
The Company anticipates substantially completing the Year 2000 project by June
1999. The total cost of the Year 2000 project is estimated to be approximately
$11.3 million, which includes approximately $.3 million for the purchase of new
software and equipment that will be capitalized and $11 million that will be
expensed as incurred, and is not expected to have a
17
<PAGE> 40
PCS Holding Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands)
13. IMPACT OF YEAR 2000 (UNAUDITED) (CONTINUED)
material effect on the results of operations. The Company has incurred
approximately $3.4 million ($3.1 million expensed and $.3 million capitalized
for new systems and equipment) through December 31, 1997) and $10.1 million
($9.8 million expensed and $.3 million capitalized for new systems and
equipment) through December 31, 1998, related to the assessment of, and
preliminary efforts on, its Year 2000 project and the development of a
modification plan, purchase of new systems and equipment, and systems
modifications.
The costs for the year 2000 project and the date on which the Company believes
it will complete the year 2000 modifications are based on management's best
estimates, which were derived utilizing numerous assumptions of future events,
including the continued availability of certain resources. In the event that the
remediation plans are unsuccessful, the Company is developing a contingency plan
for continuing operations. The Company's operating results could be materially
impacted if actual costs of the Year 2000 project are significantly higher than
management estimates or if the systems and equipment of the Company or those of
other companies on which it relies are not compliant in a timely manner.
18
<PAGE> 41
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION
Effective October 1, 2000, Advance Paradigm, Inc. ("API") acquired all of the
equity of PCS Health Systems, Inc. ("PCS"). The aggregate purchase price paid by
API was $1.0 billion, of which API paid Rite Aid Corporation ("Rite Aid"), the
seller, $675 million in cash, and issued to Rite Aid $200 million in senior
subordinated notes and $125 million in API convertible preferred stock. The cash
portion of the purchase price was financed with the proceeds of an $825 million
senior secured credit facility and $150 million in equity financing committed by
Joseph, Littlejohn & Levy, Inc. ("JLL"). The acquisition of PCS will be
accounted for using the purchase method of accounting. The excess of the
purchase price paid over the net identifiable assets and liabilities of PCS will
be recorded as goodwill. The portion of the purchase price allocated to the net
identifiable assets and goodwill is preliminary and subject to revision
following the results of an appraisal and further identification of intangible
assets. On July 5, 2000, API merged with First Florida International Holdings,
Inc., Phoenix Communications International, Inc., Innovative Pharmaceutical
Strategies, Inc., HMN Health Services, and Mature Rx Plus of Nevada, Inc.
(collectively "FFI "). This merger was accounted for using the
pooling-of-interest method of accounting. Collectively, these acquisitions and
financing are referred to as the Combinations.
The Unaudited Pro Forma Condensed Consolidated Statements of Operations for the
year ended March 31, 2000 and the three-month period ended June 30, 2000, give
effect to the Combinations as if they occurred on April 1, 1999 and 2000,
respectively. The Unaudited Pro Forma Condensed Consolidated Balance Sheet as of
June 30, 2000, reflects the Combinations as if they had occurred on June 30,
2000. The historical financial statements of API and FFI are for the year ended
March 31, 2000. The historical financial statements of PCS are for the year
ended February 26, 2000, the most recent fiscal year for PCS. The accompanying
pro forma adjustments include: (i) the merger with FFI; (ii) the acquisition of
PCS; (iii) the establishment by API of a new credit facility; (iv) the payment
of certain fees and expenses associated with the FFI and PCS acquisitions; (v)
the issuance of equity to JLL; and (iv) the reduction of assets to reflect PCS
assets not acquired by API.
API usually implements significant changes to the operations of the entities
that it acquires to enhance profitability. In addition, API will consolidate
certain operations of PCS and API which is expected to result in costs to exit
activities during the third quarter of the fiscal year ended March 31, 2001. The
expected benefits and cost reductions anticipated by API have not been reflected
in the following Unaudited Pro forma Condensed Consolidated Financial Statements
because their realization cannot be assured. Accordingly, these Unaudited
Condensed Consolidated Pro Forma Financial Statements are not necessarily
indicative of the operating results that would have been achieved had the
Combinations occurred on April 1, 1999 and 2000, respectively.
The Unaudited Condensed Consolidated Pro Forma Financial information is based on
the historical financial statements of API and the historical financial
statements of FFI and PCS. The pro forma adjustments are based upon available
information. While the pro forma adjustments are based upon certain assumptions
that API considers reasonable in the circumstances, final amounts will differ
from those set forth. These adjustments are directly attributable to the
transactions referenced above and are expected to have a continuing impact on
the API business, results of operations, and financial position.
<PAGE> 42
ADVANCE PARADIGM, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 2000
<TABLE>
<CAPTION>
Merger
Historical Historical Pro Forma
API (A) FFI (A) Adjustments
--------------- --------------- ---------------
<S> <C> <C> <C>
REVENUES $ 1,968,406,000 $ 84,358,549 $ (24,028,253)(B)
COST OF REVENUE (1,909,461,000) (67,801,995) 24,028,253(B)
SELLING, GENERAL, AND
ADMINISTRATIVE EXPENSES (22,656,000) (16,137,173) 3,398,977(C)
--------------- --------------- ---------------
OPERATING INCOME (LOSS) 36,289,000 419,381 3,398,977
INTEREST INCOME 807,000 257,457 --
INTEREST EXPENSE (3,943,000) -- --
OTHER INCOME (EXPENSE) -- -- (1,000,000)(D)
LOSS ON ASSET DISPOSAL -- (159,748) --
--------------- --------------- ---------------
INCOME (LOSS) BEFORE INCOME TAXES 33,153,000 517,090 2,398,977
INCOME TAX (EXPENSE) BENEFIT (12,598,000) -- (983,000)(E)
--------------- --------------- ---------------
NET INCOME (LOSS) $ 20,555,000 $ 517,090 $ 1,415,977
=============== =============== ===============
P/S DIVIDENDS (L) -- -- --
NET INCOME (LOSS) AVAILABLE TO
COMMON SHAREHOLDERS $ 20,555,000
BASIC:
Net income (loss) available to common
shareholders $ 20,555,000
Net income (loss) per share $ 0.97
Weighted average shares outstanding 21,260,163 3,500,000(F)
DILUTED:
Net income (loss) available to common
shareholders $ 20,555,000
Net income (loss) per share $ 0.85
Weighted average shares outstanding 24,237,216 3,500,000(F)
<CAPTION>
API Purchase
Pro Forma Historical Pro Forma API PCS
as Adjusted PCS (A) Adjustments Pro Forma
--------------- --------------- ------------ ---------------
<S> <C> <C> <C> <C>
REVENUES $ 2,028,736,296 $ 1,264,694,000 $ -- $ 3,293,430,296
COST OF REVENUE (1,953,234,742) (1,057,413,000) -- (3,010,647,742)
SELLING, GENERAL, AND
ADMINISTRATIVE EXPENSES (35,394,196) (154,116,000) 1,388,250(G) (188,121,946)
--------------- --------------- ------------ ---------------
OPERATING INCOME (LOSS) 40,107,358 53,165,000 1,388,250 94,660,608
INTEREST INCOME 1,064,457 7,479,000 (7,479,000)(H) 1,064,457
INTEREST EXPENSE (3,943,000) (1,612,000) (81,821,667)(I) (87,376,667)
OTHER INCOME (EXPENSE) (1,000,000) -- -- (1,000,000)
LOSS ON ASSET DISPOSAL (159,748) -- -- (159,748)
--------------- --------------- ------------ ---------------
INCOME (LOSS) BEFORE INCOME TAXES 36,069,067 59,032,000 (87,912,417) 7,188,650
INCOME TAX (EXPENSE) BENEFIT (13,581,000) (37,536,000) 37,356,721(J) (13,760,279)
--------------- --------------- ------------ ---------------
NET INCOME (LOSS) $ 22,488,067 $ 21,496,000 $(50,555,696) $ (6,571,629)
=============== =============== ============ ===============
P/S DIVIDENDS (L) -- -- -- --
NET INCOME (LOSS) AVAILABLE TO
COMMON SHAREHOLDERS $ 22,488,067 $ (6,571,629)
BASIC:
Net income (loss) available to
common shareholders $ 22,488,067 $ (6,571,629)
Net income (loss) per share $ 0.91 $ (0.23)
Weighted average shares
outstanding 24,760,163 4,207,000(K) 28,967,163
DILUTED:
Net income (loss) available to
common shareholders $ 22,488,067 $ --(M)
Net income (loss) per share $ 0.81 --(M)
Weighted average shares
outstanding 27,737,216 -- --(M)
</TABLE>
The accompanying notes are an integral part of this unaudited pro forma
financial statement.
3
<PAGE> 43
ADVANCE PARADIGM, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE THREE-MONTHS ENDED JUNE 30, 2000
<TABLE>
<CAPTION>
Merger
Historical Historical Pro Forma
API (A) FFI (A) Adjustments
------------- ------------- -------------
<S> <C> <C> <C>
REVENUES $ 594,327,000 $ 23,113,200 $ (6,300,000)(B)
COST OF SALES (576,612,000) (18,648,026) 6,300,000(B)
SELLING, GENERAL, AND
ADMINISTRATIVE EXPENSES (7,328,000) (4,521,737) 1,917,162(C)
------------- ------------- -------------
OPERATING INCOME (LOSS) 10,387,000 (56,563) 1,917,162
INTEREST INCOME 259,000 91,097 --
INTEREST EXPENSE (1,130,000) -- --
OTHER INCOME (EXPENSE) -- -- (1,000,000)(D)
------------- ------------- -------------
INCOME (LOSS) BEFORE INCOME TAXES 9,516,000 34,534 917,162
INCOME TAX BENEFIT (EXPENSE) (3,616,000) -- (452,000)(E)
------------- ------------- -------------
NET INCOME (LOSS) $ 5,900,000 $ 34,534 $ 465,162
============= ============= =============
P/S DIVIDENDS (L) $ -- $ -- $ --
NET INCOME (LOSS) AVAILABLE TO COMMON
SHAREHOLDERS $ 5,900,000
BASIC:
Net income (loss) available to common
shareholders $ 5,900,000
Net income (loss) per share $ 0.27
Weighted average shares outstanding 21,537,000 3,500,000(F)
DILUTED:
Net income (loss) available to common
shareholders $ 5,900,000
Net income (loss) per share $ 0.25
Weighted average shares outstanding 23,479,000 3,500,000(F)
<CAPTION>
API Purchase
Pro Forma Historical Pro Forma API PCS
as Adjusted PCS (A) Adjustments Pro Forma
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES $ 611,140,200 $ 332,874,000 $ -- $ 944,014,200
COST OF SALES (588,960,026) (200,488,000) -- (789,448,026)
SELLING, GENERAL, AND
ADMINISTRATIVE EXPENSES (9,932,575) (109,554,000) (2,100,250)(G) (121,586,825)
------------- ------------- ------------- -------------
OPERATING INCOME (LOSS) 12,247,599 22,832,000 (2,100,250) 32,979,349
INTEREST INCOME 350,097 3,119,000 (3,119,000)(H) 350,097
INTEREST EXPENSE (1,130,000) (270,000) (20,444,000)(I) (21,844,000)
OTHER INCOME (EXPENSE) (1,000,000) -- -- (1,000,000)
------------- ------------- ------------- -------------
INCOME (LOSS) BEFORE INCOME TAXES 10,467,696 25,681,000 (25,663,250) 10,485,446
INCOME TAX BENEFIT (EXPENSE) (4,068,000) (13,846,000) 10,527,784(J) (7,386,216)
------------- ------------- ------------- -------------
NET INCOME (LOSS) $ 6,399,696 $ 11,835,000 $ (15,135,466) $ 3,099,230
============= ============= ============= =============
P/S DIVIDENDS (L) $ -- $ -- $ -- $ --
NET INCOME (LOSS) AVAILABLE TO COMMON
SHAREHOLDERS $ 6,399,696 $ 3,099,230
BASIC:
Net income (loss) available to common
shareholders $ 6,399,696 $ 3,099,230
Net income (loss) per share $ 0.26 $ 0.11
Weighted average shares outstanding 25,037,000 $ 4,207,000(K) $ 29,244,000
DILUTED:
Net income (loss) available to common
shareholders $ 6,399,696 $ 3,099,230
Net income (loss) per share $ 0.24 $ 0.08
Weighted average shares outstanding 26,979,000 13,750,000(K) 40,729,000
</TABLE>
The accompanying notes are an integral part of this unaudited pro forma
financial statement.
4
<PAGE> 44
ADVANCE PARADIGM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
DETERMINATION AND ALLOCATION OF PCS PURCHASE PRICE
At the date of the PCS acquisition, all of the equity of PCS was purchased for
$1 billion. The PCS acquisition will be accounted for using the purchase method
of accounting for business combinations. The preliminary allocation of the pro
forma purchase price is as follows:
<TABLE>
<CAPTION>
April 1, 1999 April 1, 2000
--------------- ---------------
<S> <C> <C>
PCS purchase price $ 1,000,000,000 $ 1,000,000,000
Transaction Costs 8,700,000 8,700,000
--------------- ---------------
Pro forma purchase price 1,008,700,000 1,008,700,000
Net liabilities assumed (the liabilities assumed
exceed the net identifiable assets acquired) 243,989,000 429,963,000
--------------- ---------------
Excess purchase price $ 1,252,689,000 $ 1,438,663,000
=============== ===============
Allocation of excess purchase price:
Goodwill $ 1,091,389,000 $ 1,251,363,000
Intangible assets 445,000,000 511,000,000
Deferred income tax liabilities (273,000,000) (313,000,000)
Accrued liabilities (10,700,000) (10,700,000)
--------------- ---------------
Excess purchase price $ 1,252,689,000 $ 1,438,663,000
=============== ===============
</TABLE>
(A) Reflects the audited historical consolidated statement of operations of API
for the year ended March 31, 2000, and the audited historical combined
statement of operations of FFI for the year ended March 31, 2000, and the
unaudited consolidated statement of operations of API for the three-month
period ended June 30, 2000, and the unaudited condensed combined statement
of operations of FFI for the three-month period ended June 30, 2000.
The historical PCS column reflects the audited historical consolidated
statement of operations of PCS for the year ended February 26, 2000, and
the unaudited consolidated statement of operations of PCS for the
three-month period ended May 27, 2000.
(B) Reflects the elimination of intercompany transactions between API and FFI.
(C) Reflects the reduction of salary expense paid by FFI to its shareholders to
more appropriately reflect the ongoing management salaries under new
employment agreements.
(D) Reflects the transaction costs incurred as a result of the merger with FFI.
These costs are assumed to be partially deductible for income tax purposes.
(E) Reflects the tax effects, of the merger pro forma adjustments, at API's
effective tax rate of 38% and adjustments to the provision for income taxes
for the realization of a deferred tax asset related to conversion of FFI
from an S-corporation to a C-corporation.
(F) Reflects the issuance of 3,500,000 shares of API common stock to effect the
merger with FFI.
5
<PAGE> 45
(G) The pro forma adjustment to increase selling, general and administrative
expenses results from (i) the elimination of historical PCS amortization of
goodwill and intangible assets; (ii) the addition of pro forma goodwill and
intangible asset amortization resulting from the preliminary allocation of
$1,091,389,000 and $1,251,363,000 at March 31, 1999 and 2000, respectively,
to goodwill and $445,000,000 and $511,000,000 at March 31, 1999 and 2000,
respectively, to intangible assets; (iii) the elimination of historical PCS
depreciation expense on the PCS land and building not acquired; and (iv)
the addition of lease expense resulting from the lease of land and
buildings for the PCS operations. Goodwill is expected to be amortized over
30 years and the intangible assets will be amortized over their estimated
useful lives of 5-40 years. These adjustments are as follows:
<TABLE>
<CAPTION>
March 31, 2000 June 30, 2000
-------------- -------------
<S> <C> <C>
Elimination of historical PCS goodwill amortization $ (32,064,000) $ (8,015,000)
Elimination of historical PCS intangible asset amortization (29,653,000) (7,413,250)
Pro forma goodwill amortization 36,380,000 10,853,500
Pro forma intangible asset amortization 21,248,750 6,000,000
Elimination of historical PCS depreciation expense (1,500,000) (375,000)
Pro forma lease expense 4,200,000 1,050,000
------------- ------------
Pro forma adjustment $ (1,388,250) $ 2,100,250
============= ============
</TABLE>
(H) Reflects the elimination of historical intercompany interest income of PCS
due to Rite Aid.
(I) Reflects pro forma interest expense (at assumed rates of interest) for the
year ended March 31, 2000, and for the three months ended June 30, 2000,
resulting from pro forma borrowings and the amortization of deferred
financing costs paid to obtain the Senior Secured Credit Facility and the
elimination of historical interest expense of API and PCS. These
adjustments are as follows:
<TABLE>
<CAPTION>
March 31, 2000 June 30, 2000
-------------- -------------
<S> <C> <C>
Revolver, $70,000,000 @ 9.8% $ 6,860,000 $ 1,715,000
Term Note A, $150,000,000 @ 9.8% 14,700,000 3,675,000
Term Note B, $400,000,000 @ 10.3% 41,200,000 10,300,000
Senior Subordinate Notes, $200,000,000 @ 11% 22,000,000 5,500,000
Deferred financing costs (amortized over 5-7 years) 2,616,667 654,000
Less API historical interest expense (3,943,000) (1,130,000)
Less PCS historical interest expense (1,612,000) (270,000)
------------ ------------
Pro forma adjustment $ 81,821,667 $ 20,444,000
============ ============
</TABLE>
(J) The tax effects of pro forma adjustments were calculated using statutory
rates in effect during the year ended March 31, 2000, and for the three
months ended June 30, 2000. The amortization of goodwill and intangible
assets are not deductible for income tax purposes. In addition, a portion
of the acquisition costs are nondeductible.
(K) Reflects the issuance of 4,207,000 shares of common stock and 3,293,000
shares of convertible Preferred Stock to JLL and 6,250,000 of Convertible
Preferred Stock to Rite Aid.
(L) The convertible preferred stock accrues dividends at 11% per annum of the
issue price. However, dividends do not accrue for the first 120 days
following issuance or subsequent to shareholder approval of Class B
common stock. These pro forma adjustments assume that the Class B common
stock will be approved prior to 120 days from issuance. Thus no preferred
dividends are reflected in the adjustments.
6
<PAGE> 46
(M) Potential dilutive securities were not included in the computation of
fully diluted earnings per share. Inclusion of such securities would have
been anti-dilutive, therefore, fully diluted earnings per share is equal
to basic earnings per share.
SUPPLEMENTAL INFORMATION
API will consolidate certain operations of PCS and API which is expected to
result in costs to exit activities during the third quarter of the fiscal year
ended March 31, 2001. The consolidation is expected to include a facility
closure and other synergistic activities. These events are expected to result in
a pretax charge of approximately $18 million to operations.
7
<PAGE> 47
ADVANCE PARADIGM, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
AS OF JUNE 30, 2000
<TABLE>
<CAPTION>
Merger API
Historical Historical Pro Forma Pro Forma
API(A) FFI(A) Adjustments as Adjusted
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 51,614,000 $ 5,053,617 $ -- $ 56,667,617
Accounts receivable, net 193,121,000 12,864,770 (5,000,000)(B) 200,985,770
Due from Rite Aid -- -- -- --
Inventories 6,288,000 -- -- 6,288,000
Prepaid expenses and other 3,025,000 -- -- 3,025,000
Deferred income tax asset -- -- 376,947(C) 376,947
--------------- --------------- --------------- ---------------
Total current assets 254,048,000 17,918,387 (4,623,053) 267,343,334
PROPERTY AND EQUIPMENT, net 37,451,000 716,230 -- 38,167,230
INTANGIBLE ASSETS, net 895,000 -- -- 895,000
GOODWILL 99,288,000 -- -- 99,288,000
OTHER ASSETS 7,582,000 19,064 -- 7,601,064
--------------- --------------- --------------- ---------------
Total assets $ 399,264,000 $ 18,653,681 $ (4,623,053) $ 413,294,628
=============== =============== =============== ===============
CURRENT LIABILITIES:
Accounts payable $ 227,170,000 $ 20,640,862 $ (4,000,000)(D) $ 243,810,862
Accrued salaries and benefits 4,506,000 1,585,781 -- 6,091,781
Income taxes payable 2,779,000 -- -- 2,779,000
Other accrued expenses 2,822,000 -- -- 2,822,000
--------------- --------------- --------------- ---------------
Total current liabilities 237,277,000 22,226,643 (4,000,000) 255,503,643
NONCURRENT LIABILITIES:
Long-term debt 50,000,000 -- -- 50,000,000
Revolver -- -- -- --
Term note -- -- -- --
Senior subordinate debt -- -- -- --
Deferred income taxes 4,324,000 -- -- 4,324,000
Other noncurrent liabilities 2,157,000 21,778 -- 2,178,778
--------------- --------------- --------------- ---------------
Total liabilities 293,758,000 22,248,421 (4,000,000) 312,006,421
--------------- --------------- --------------- ---------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock -- -- -- --
Common stock 215,000 12,355 22,645(E) 250,000
Additional paid-in-capital 58,808,000 239,990 (22,656)(E) 59,025,334
Retained earnings (deficit) 46,483,000 (3,847,074) (623,053)(F) 42,012,873
--------------- --------------- --------------- ---------------
105,506,000 (3,594,729) (623,064) 101,288,207
Less- Treasury stock -- (11) 11(E) --
--------------- --------------- --------------- ---------------
Total stockholders' equity 105,506,000 (3,594,740) (623,053) 101,288,207
--------------- --------------- --------------- ---------------
Total liabilities and $ 399,264,000 $ 18,653,681 $ (4,623,053) $ 413,294,628
stockholders' equity =============== =============== =============== ===============
<CAPTION>
Purchase
Historical Pro Forma API
PCS (A) Adjustments Pro Forma
--------------- --------------- ---------------
<S> <C> <C> <C>
Cash and cash equivalents $ 3,021,000 $ 20,600,000(G) $ 80,288,617
Accounts receivable, net 535,549,000 -- 736,534,770
Due from Rite Aid 270,401,000 (270,401,000)(H) --
Inventories 25,577,000 -- 31,865,000
Prepaid expenses and other 3,906,000 -- 6,931,000
Deferred income tax asset 1,153,000 -- 1,529,947
--------------- --------------- ---------------
Total current assets 839,607,000 (249,801,000) 857,149,334
PROPERTY AND EQUIPMENT, net 91,823,000 (100,092,000)(H) 29,898,230
INTANGIBLE ASSETS, net 601,832,000 (107,832,000)(I) 494,895,000
GOODWILL 1,242,839,000 19,509,000(J) 1,361,636,000
OTHER ASSETS -- 15,700,000(K) 23,301,064
--------------- --------------- ---------------
Total assets $ 2,776,101,000 $ (422,516,000) $ 2,766,879,628
=============== =============== ===============
CURRENT LIABILITIES:
Accounts payable $ 814,386,000 $ -- $ 1,058,196,862
Accrued salaries and benefits -- -- 6,091,781
Income taxes payable -- -- 2,779,000
Other accrued expenses 163,975,000 12,700,000(M) 179,497,000
--------------- --------------- ---------------
Total current liabilities 978,361,000 12,700,000 1,246,564,643
NONCURRENT LIABILITIES:
Long-term debt -- (50,000,000)(L) --
Revolver -- 70,000,000(L) 70,000,000
Term note -- 550,000,000(L) 550,000,000
Senior subordinate debt -- 200,000,000(L) 200,000,000
Deferred income taxes 228,986,000 74,014,000(N) 307,324,000
Other noncurrent liabilities 16,524,000 -- 18,702,778
--------------- --------------- ---------------
Total liabilities 1,223,871,000 856,714,000 2,392,591,421
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock -- 191,000,000(O) 191,000,000
Common stock 1,000 41,070(O) 292,070
Additional paid-in-capital 1,518,472,000 (1,436,514,070)(O) 140,983,264
Retained earnings (deficit) 33,757,000 (33,757,000)(O) 42,012,873
--------------- --------------- ---------------
1,552,230,000 (1,279,230,000) 374,288,207
Less- Treasury stock -- -- --
--------------- --------------- ---------------
Total stockholders' equity 1,552,230,000 (1,279,230,000) 374,288,207
--------------- --------------- ---------------
Total liabilities and stockholders' equity $ 2,776,101,000 $ (422,516,000) $ 2,766,879,628
=============== =============== ===============
</TABLE>
The accompanying notes are an integral part of this unaudited pro forma
financial statement.
8
<PAGE> 48
ADVANCE PARADIGM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
DETERMINATION AND ALLOCATION OF PCS PURCHASE PRICE
At the date of the PCS acquisition, all of the equity of PCS will be purchased
for $1 billion. The PCS acquisition will be accounted for using the purchase
method of accounting for business combinations. The preliminary allocation of
the pro forma purchase price is as follows:
<TABLE>
<CAPTION>
June 30, 2000
---------------
<S> <C>
PCS purchase price $ 1,000,000,000
Transaction cost 8,700,000
---------------
Pro forma purchase price 1,008,700,000
Net liabilities assumed (the liabilities assumed
exceed the net identifiable assets acquired) 433,948,000
---------------
Excess purchase price $ 1,442,648,000
===============
Allocation of excess purchase price:
Goodwill $ 1,262,348,000
Intangible assets 494,000,000
Deferred income tax liabilities (303,000,000)
Accrued liabilities (10,700,000)
---------------
Excess purchase price $ 1,442,648,000
===============
</TABLE>
(A) Reflects the unaudited historical consolidated balance sheet of API as of
June 30, 2000, the unaudited historical combined balance sheet of FFI as of
June 30, 2000, and the unaudited historical consolidated balance sheet of
PCS as of May 27, 2000.
(B) Reflects the elimination of intercompany transactions between API and FFI.
(C) Reflects the realization of a deferred tax asset from converting FFI from
an S-corporation to a C-corporation, and the effects of deferred tax assets
as a result of the FFI merger.
(D) Reflects the transaction costs incurred as a result of the FFI merger.
(E) Represents the exchange of 3,500,000 common shares of API in the FFI
merger.
(F) Reflects the adjustment to retained earnings for transaction costs
associated with the FFI acquisition and the realization of deferred tax
assets as follows:
<TABLE>
<S> <C>
Transaction cost (see (C)) $(1,000,000)
Deferred income tax assets 376,947
-----------
Total $ (623,053)
===========
</TABLE>
(G) Reflects the cash proceeds received in excess of cash used to acquire the
equity of PCS. The excess cash is attributable to amounts drawn on the
revolver portion of the Senior Secured Credit Facilities. The excess cash
will primarily be utilized in operations.
(H) Reflects the elimination of a receivable from Rite Aid and land and a
building that was not acquired by API.
9
<PAGE> 49
(I) Reflects the pro forma adjustment to eliminate the certain historical PCS
identifiable intangible assets and to record the purchase price, based on a
preliminary allocation, to identified intangible assets, as follows:
<TABLE>
<S> <C>
Elimination of PCS historical intangible assets $ (601,832,000)
Preliminary allocation of the purchase price to
identifiable intangible assets 494,000,000
---------------
Pro forma adjustment $ (107,832,000)
===============
</TABLE>
(J) Reflects the pro forma adjustment to eliminate the historical goodwill of
PCS and to allocate the remaining excess purchase price to goodwill.
<TABLE>
<S> <C>
Excess purchase price (See page 9) $ 1,442,648,000
Allocation of excess purchase price-
Identifiable intangible assets (494,000,000)
Deferred income tax liabilities 303,000,000
Accrued liabilities 10,700,000
Elimination of historical goodwill of PCS (1,242,839,000)
---------------
Pro forma adjustment $ 19,509,000
===============
</TABLE>
(K) Reflects the pro forma adjustment to recognize $15,700,000 of deferred
financing costs related to the new Senior Secured Credit Facility. These
assets will be amortized over five to seven years.
(L) Reflects the pro forma adjustment to recognize the API obligations under
the Senior Secured Credit Facility, and the Senior Subordinated Notes
issued to Rite Aid and to eliminate the API historical debt refinanced in
conjunction with the Senior Secured Credit Facility. The Senior
Subordinated Notes have been recorded based upon a preliminary estimate of
their fair value.
(M) Reflects the recording of accrued acquisition costs and equity issuance
costs related to the PCS and JLL transactions. In addition, API has
determined that certain operations of PCS will be discontinued and
personnel will be relocated. The pro forma adjustment includes an estimated
accrual for these events. The adjustments are as follows:
<TABLE>
<S> <C>
Accrued acquisition cost $ 8,700,000
JLL transaction cost 2,000,000
Accrued PCS costs 2,000,000
---------------
$ 12,700,000
===============
</TABLE>
(N) Reflects the elimination of PCS deferred income tax liabilities and the
establishment of an API deferred tax liability associated with recognizing
the identifiable intangible assets as follows:
<TABLE>
<S> <C>
Elimination of PCS deferred income tax liability $ (228,986,000)
Recognition of PCS deferred income tax liability 303,000,000
---------------
Total adjustment $ 74,014,000
===============
</TABLE>
10
<PAGE> 50
(O) Pro forma adjustment to eliminate the net equity of PCS and to record the
following:
<TABLE>
<CAPTION>
Additional Retained
Preferred Common Paid-In Earnings
Stock Stock Capital Deficit
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Elimination of PCS equity $ -- $ (1,000) $(1,518,472,000) $ (33,757,000)
Issuance of convertible
preferred stock to JLL
and Rite Aid 191,000,000 -- -- --
Issuance of common stock
to JLL -- 42,070 83,957,930 --
JLL transaction cost -- -- (2,000,000) --
--------------- --------------- --------------- ---------------
Total adjustment $ 191,000,000 $ 41,070 $(1,436,514,070) $ (33,757,000)
=============== =============== =============== ===============
</TABLE>
11
