3. Lease Termination and Impairment Charges

Impairment Charges

The Company evaluates long-lived assets for impairment whenever events or changes in circumstances indicate that an asset group has a carrying value that may not be recoverable. The individual operating store is the lowest level for which cash flows are identifiable. As such, the Company evaluates individual stores for recoverability of assets. To determine if a store needs to be tested for recoverability, the Company considers items such as decreases in market prices, changes in the manner in which the store is being used or physical condition, changes in legal factors or business climate, an accumulation of losses significantly in excess of budget, a current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection of continuing losses, or an expectation that the store will be closed or sold.

The Company monitors new and recently relocated stores against operational projections and other strategic factors such as regional economics, new competitive entries and other local market considerations to determine if an impairment evaluation is required. For other stores, it performs a recoverability analysis if it has experienced current-period and historical cash flow losses.

In performing the recoverability test, the Company compares the expected future cash flows of a store to the carrying amount of its assets. Significant judgment is used to estimate future cash flows. Major assumptions that contribute to its future cash flow projections include expected sales, gross profit, and distribution expenses; expected costs such as payroll, occupancy costs and advertising expenses; and estimates for other significant selling, and general and administrative expenses. Many long-term macro-economic and industry factors are considered, both quantitatively and qualitatively, in the future cash flow assumptions. In addition to current and expected economic conditions such as inflation, interest and unemployment rates that affect customer shopping patterns, the Company considers that it operates in a highly competitive industry which includes the actions of other national and regional drugstore chains, independently owned drugstores, supermarkets, mass merchandisers, dollar stores and internet pharmacies. Many of its competitors are spending significant capital and promotional dollars in certain geographies to gain market share. The Company has assumed certain sales growth from its loyalty program and other initiatives to grow sales. Recent and proposed Pharmacy Benefit Management consolidation and efforts of third party public and private payers have reduced pharmacy reimbursement rates in recent years. The Company expects this rate compression, which currently affects approximately 97% of its pharmacy business, to continue to affect it in the foreseeable future. The Company operates in a highly regulated industry and must make assumptions related to Federal and State efforts and proposals to affect the pricing and regulations related to prescription drugs, as well as, expected revenues and costs related to the Patient Protection and Affordable Care Act (health care reform).

Additionally, the Company takes into consideration that certain operating stores are executing specific improvement plans which are monitored quarterly to recoup recent capital investments, such as an acquisition of an independent pharmacy, which it has made to respond to specific competitive or local market conditions, or have specific programs tailored towards a specific geography or market.

The Company recorded impairment charges of $13,077 in fiscal 2014, $24,892 in fiscal 2013 and $51,998 in fiscal 2012. The Company's methodology for recording impairment charges has not changed materially, and has been consistently applied in the periods presented.

At March 1, 2014, $1.927 billion of the Company's long-lived assets, including intangible assets, were associated with 4,587 active operating stores.

If an operating store's estimated future undiscounted cash flows are not sufficient to cover its carrying value, its carrying value is reduced to fair value which is its estimated future discounted cash flows. The discount rate is commensurate with the risks associated with the recovery of a similar asset.

An impairment charge is recorded in the period that the store does not meet its original return on investment and/or has an operating loss for the last 2 years and its projected cash flows do not exceed its current asset carrying value. The amount of the impairment charge is the entire difference between the current asset carrying value and the estimated fair value of the assets using discounted future cash flows. Most stores are fully impaired in the period that the impairment charge is originally recorded.

The Company recorded impairment charges for active stores of $11,748 in fiscal 2014, $23,973 in fiscal 2013 and $43,353 in fiscal 2012.

The Company reviews key performance results for active stores on a quarterly basis and approves certain stores for closure. Impairment for closed stores, if any (many stores are closed on lease expiration), are recorded in the quarter the closure decision is made and approved. Closure decisions are made on an individual store or regional basis considering all of the macro-economic, industry and other factors discussed above, in addition to, the active store's individual operating results. The Company currently has no plans to close a significant number of operating stores in future periods. In the next fiscal year, the Company currently expects to close fewer than 40 stores, primarily as a result of lease expirations. The Company recorded impairment charges for closed facilities of $1,329 in fiscal 2014, $919 in fiscal 2013 and $8,645 in fiscal 2012.

Included in the impairment charges noted above, the Company recorded charges of $798 in fiscal 2014, $594 in fiscal 2013 and $5,863 in fiscal 2012 for existing owned surplus property. Assets to be disposed of are evaluated quarterly to determine if an additional impairment charge is required. Fair value estimates are provided by independent brokers who operate in the local markets where the assets are located.

The following table summarizes the impairment charges and number of locations, segregated by closed facilities and active stores that have been recorded in fiscal 2014, 2013 and 2012:

	Year Ended

	March 1, 2014				March 2, 2013				March 3, 2012
	Number		Charge		Number		Charge		Number		Charge
Closed facilities:
Actual and approved store closings		31	$	531		29	$	325		55	$	2,283
Actual and approved relocations		—		—		—		—		2		499
Existing surplus properties		7		798		5		594		12		5,863


Total impairment charges-closed facilities		38		1,329		34		919		69		8,645
Active stores:
Additional current period charges for stores previously impaired in prior periods(1)		378		4,162		469		5,835		591		9,822
Charges for new, relocated and remodeled stores that did not meet their asset recoverability test in the current period(2)		1		4,028		14		9,190		19		18,926
Charges for the remaining stores that did not meet their asset recoverability test in the current period(3)		17		3,558		47		8,948		53		14,605


Total impairment charges—active stores		396		11,748		530		23,973		663		43,353
Total impairment charges—all locations		434	$	13,077		564	$	24,892		732	$	51,998




Total number of active stores		4,587				4,623				4,667
Stores impaired in prior periods with no current charge		709				588				428
Stores with a current period charge		396				530				663


Total cumulative active stores with impairment charges		1,105				1,118				1,091

(1): These charges are related to stores that were impaired for the first time in prior periods. Most active stores, requiring an impairment charge, are fully impaired in the first period that they do not meet their asset recoverability test. However, in each prior period presented, a minority of stores were partially impaired since their fair value supported a reduced net book value. Accordingly, these stores may be further impaired in the current and future periods as a result of changes in their actual or projected cash flows, or changes to their fair value estimates. Also, the Company makes ongoing capital additions to certain stores to improve their operating results or to meet geographical competition, which if later are deemed to be unrecoverable, will be impaired in future periods. Of this total, 375, 464 and 583 stores for fiscal years 2014, 2013 and 2012 respectively have been fully impaired.
(2): These charges are related to new stores (open at least 3 years) and relocated stores (relocated in the last 2 years) and significant strategic remodels (remodeled in the last year) that did not meet their recoverability test during the current period. These stores have not met their original return on investment projections and have a historical loss of at least 2 years. Their future cash flow projections do not recover their current carrying value. Of this total, 1, 14 and 19 stores for fiscal years 2014, 2013 and 2012 respectively have been fully impaired.
(3): These charges are related to the remaining active stores that did not meet the recoverability test during the current period. These stores have a historical loss of at least 2 years. Their future cash flow projections do not recover their current carrying value. Of this total, 14, 43 and 43 stores for fiscal years 2014, 2013 and 2012 respectively have been fully impaired.

The primary drivers of its impairment charges are each store's current and historical operating performance and the assumptions that the Company makes about each store's operating performance in future periods. Projected cash flows are updated based on the next year's operating budget which includes the qualitative factors noted above. The Company is unable to predict with any degree of certainty which individual stores will fall short or exceed future operating plans. Accordingly, the Company is unable to describe future trends that would affect its impairment charges, including the likely stores and their related asset values that may fail their recoverability test in future periods.

The Company utilizes the three-level valuation hierarchy for the recognition and disclosure of fair value measurements. The categorization of assets and liabilities within this hierarchy is based upon the lowest level of input that is significant to the measurement of fair value. The three levels of the hierarchy consist of the following:

•

Level 1—Inputs to the valuation methodology are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

•

Level 2—Inputs to the valuation methodology are quoted prices for similar assets and liabilities in active markets, quoted prices in markets that are not active or inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the instrument.

•

Level 3—Inputs to the valuation methodology are unobservable inputs based upon management's best estimate of inputs market participants could use in pricing the asset or liability at the measurement date, including assumptions about risk.

Long-lived non-financial assets are measured at fair value on a nonrecurring basis for purposes of calculating impairment using Level 2 and Level 3 inputs as defined in the fair value hierarchy. The fair value of long-lived assets using Level 2 inputs is determined by evaluating the current economic conditions in the geographic area for similar use assets. The fair value of long-lived assets using Level 3 inputs is determined by estimating the amount and timing of net future cash flows (which are unobservable inputs) and discounting them using a risk-adjusted rate of interest (which is Level 1). The Company estimates future cash flows based on its experience and knowledge of the market in which the store is located. Significant increases or decreases in actual cash flows may result in valuation changes.

The table below sets forth by level within the fair value hierarchy the long-lived assets as of the impairment measurement date for which an impairment assessment was performed and total losses as of March 1, 2014 and March 2, 2013:

	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Fair Values as of Impairment Date		Total Charges March 1, 2014

Long-lived assets held and used	$	—	$	42	$	15,051	$	15,093	$	(12,279	)
Long-lived assets held for sale		—		14,656		—		14,656		(798	)


Total	$	—	$	14,698	$	15,051	$	29,749	$	(13,077	)

	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Fair Values as of Impairment Date		Total Charges March 2, 2013

Long-lived assets held and used	$	—	$	1,018	$	21,739	$	22,757	$	(24,298	)
Long-lived assets held for sale		—		1,842		—		1,842		(594	)


Total	$	—	$	2,860	$	21,739	$	24,599	$	(24,892	)

Lease Termination Charges

Charges to close a store, which principally consist of continuing lease obligations, are recorded at the time the store is closed and all inventory is liquidated, pursuant to the guidance set forth in ASC 420, "Exit or Disposal Cost Obligations." The Company calculates the liability for closed stores on a store-by-store basis. The calculation includes the discounted effect of future minimum lease payments and related ancillary costs, from the date of closure to the end of the remaining lease term, net of estimated cost recoveries that may be achieved through subletting or favorable lease terminations. The Company evaluates these assumptions each quarter and adjusts the liability accordingly.

In fiscal 2014, 2013 and 2012, the Company recorded lease termination charges of $28,227, $45,967 and $48,055, respectively. These charges related to changes in future assumptions, interest accretion and provisions for 15 stores in fiscal 2014, 14 stores in fiscal 2013, and 23 stores in fiscal 2012. Of the approximate 40 store closures for fiscal 2015, the Company anticipates that 15 will require a store lease closing provision.

As part of its ongoing business activities, the Company assesses stores and distribution centers for potential closure. Decisions to close or relocate stores or distribution centers in future periods would result in lease termination charges for lease exit costs and liquidation of inventory, as well as impairment of assets at these locations. The following table reflects the closed store and distribution center charges that relate to new closures, changes in assumptions and interest accretion:

	Year Ended

	March 1, 2014 (52 Weeks)			March 2, 2013 (52 Weeks)			March 3, 2012 (53 Weeks)
Balance—beginning of year	$	323,757		$	367,864		$	405,350
Provision for present value of noncancellable lease payments of closed stores		11,646			14,440			11,832
Changes in assumptions about future sublease income, terminations and change in interest rates		(4,343	)		9,023			11,305
Interest accretion		21,250			23,246			26,084
Cash payments, net of sublease income		(68,040	)		(90,816	)		(86,707	)


Balance—end of year	$	284,270		$	323,757		$	367,864

The Company's revenues and income (loss) before income taxes for fiscal 2014, 2013, and 2012 included results from stores that have been closed or are approved for closure as of March 1, 2014. The revenue, operating expenses and income (loss) before income taxes of these stores for the periods are presented as follows:

	Year Ended

	March 1, 2014			March 2, 2013			March 3, 2012
Revenues	$	89,416		$	139,082		$	258,263
Operating expenses		100,889			153,187			284,803
Gain from sale of assets		(13,074	)		(19,894	)		(12,206	)
Other (income) expenses		(8,268	)		622			(7,874	)
Income (loss) before income taxes		9,869			5,167			(6,460	)
Included in these stores' income (loss) before income taxes are:
Depreciation and amortization		607			1,342			3,038
Inventory liquidation charges		621			708			598

The above results are not necessarily indicative of the impact that these closures will have on revenues and operating results of the Company in the future, as the Company often transfers the business of a closed store to another Company store, thereby retaining a portion of these revenues and operating expenses.