RITE AID CORP - Quarter Report: 2017 December (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

x       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended December 2, 2017

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from               to

 

Commission File Number: 1-5742

 

RITE AID CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code: (717) 761-2633.

 

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report):

Not Applicable

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).  Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “Large Accelerated Filer,” “Accelerated Filer,” “Smaller Reporting Company” and “Emerging Growth Company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer x

Accelerated Filer o

Non-Accelerated Filer o (Do not check if a smaller reporting company)

Smaller reporting company o Emerging growth company o

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

 

Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange act).  Yes o  No x

 

The registrant had 1,067,509,844 shares of its $1.00 par value common stock outstanding as of December 28, 2017.

 

 

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RITE AID CORPORATION

 

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	Cautionary Statement Regarding Forward-Looking Statements	3
PART I FINANCIAL INFORMATION
ITEM 1.	Financial Statements (unaudited):
	Condensed Consolidated Balance Sheets as of December 2, 2017 and March 4, 2017	5
	Condensed Consolidated Statements of Operations for the Thirteen Week Periods Ended December 2, 2017 and November 26, 2016	6
	Condensed Consolidated Statements of Comprehensive Income for the Thirteen Week Periods Ended December 2, 2017 and November 26, 2016	7
	Condensed Consolidated Statements of Operations for the Thirty-Nine Week Periods Ended December 2, 2017 and November 26, 2016	8
	Condensed Consolidated Statements of Comprehensive Income for the Thirty-Nine Week Periods Ended December 2, 2017 and November 26, 2016	9
	Condensed Consolidated Statements of Cash Flows for the Thirty-Nine Week Periods Ended December 2, 2017 and November 26, 2016	10
	Notes to Condensed Consolidated Financial Statements	11
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	39
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	52
ITEM 4.	Controls and Procedures	53
PART II OTHER INFORMATION
ITEM 1.	Legal Proceedings	53
ITEM 1A.	Risk Factors	53
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	53
ITEM 3.	Defaults Upon Senior Securities	55
ITEM 4.	Mine Safety Disclosures	55
ITEM 5.	Other Information	55
ITEM 6.	Exhibits	55

 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

This report, as well as our other public filings or public statements, include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are often identified by terms and phrases such as “anticipate,” “believe,” “intend,” “estimate,” “expect,” “continue,” “should,” “could,” “may,” “plan,” “project,” “predict,” “will” and similar expressions and include references to assumptions and relate to our future prospects, developments and business strategies.

 

Factors that could cause actual results to differ materially from those expressed or implied in such forward-looking statements include, but are not limited to:

 

·                  our high level of indebtedness;

 

·                  our ability to make interest and principal payments on our debt and satisfy the other covenants contained in our credit facilities and other debt agreements;

 

·                  the continued impact of private and public third party payors reduction in prescription drug reimbursement rates and their ongoing efforts to limit access to payor networks, including through mail order;

 

·                  our ability to achieve the benefits of our efforts to reduce the costs of our generic and other drugs, and our ability to achieve drug pricing efficiencies;

 

·                  the impact of the loss of one or more major third party payor contracts;

 

·                  the inability to complete the remaining subsequent closings of the Sale (as defined in Note 3 below) and recognize the corresponding expected gain due to the failure to satisfy the minimal remaining conditions applicable only to the stores being transferred at such subsequent closing and other risks related to obtaining the requisite consents to the remaining subsequent closings of the Sale;

 

·                  the impact on our business, operating results and relationships with customers, suppliers, third party payors, and employees, resulting from our efforts over the past two years to consummate a significant transaction with Walgreens Boots Alliance, Inc. (“WBA”), including the fact that we did not obtain the required antitrust regulatory approvals for the contemplated merger and the original version of the asset sale agreement that was entered into following the termination of the merger;

 

·                  the risk that our stock price may decline significantly if the remaining subsequent closings of the Sale are not completed;

 

·                  our ability to refinance our indebtedness on terms favorable to us;

 

·                  there may be changes to our strategy in the event that the remaining subsequent closings of the Sale do not close, which may include delaying or reducing capital or other expenditures, selling assets or other operations, closing underperforming stores, attempting to restructure or refinance our debt, seeking additional capital or incurring other costs associated with restructuring our business;

 

·                  our ability to improve the operating performance of our stores in accordance with our long term strategy;

 

·                  our ability to grow prescription count and realize front-end sales growth;

 

·                  our ability to hire and retain qualified personnel;

 

·                  decisions to close additional stores and distribution centers or undertake additional refinancing activities, which could result in charges to our operating statement;

 

·                  our ability to manage expenses and working capital;

 

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·                  continued consolidation of the drugstore and the pharmacy benefit management (“PBM”) industries;

 

·                  the risk that changes in federal or state laws or regulations, including the Health Care Education Affordability Reconciliation Act, the repeal of all or part of the Patient Protection and the Affordable Care Act (or “Patient Care Act”) and any regulations enacted thereunder may occur;

 

·                  the risk that provider and state contract changes may occur;

 

·                  risks related to compromises of our information or payment systems or unauthorized access to confidential or personal information of our associates or customers;

 

·                  our ability to maintain our current pharmacy services business and obtain new pharmacy services business, including maintaining renewals of expiring contracts, avoiding contract termination rights that may permit certain of our clients to terminate their contracts prior to their expiration and early price renegotiations prior to contract expirations;

 

·                  the continued impact of gross margin pressure in the PBM industry due to increased market competition and client demand for lower prices while providing enhanced service offerings;

 

·                  our ability to maintain our current Medicare Part D business and obtain new Medicare Part D business, as a result of the annual Medicare Part D competitive bidding process;

 

·                  the expiration or termination of our Medicare or Medicaid managed care contracts by federal or state governments;

 

·                  risks related to other business effects, including the effects of industry, market, economic, political or regulatory conditions, future exchange or interest rates or credit ratings, changes in tax laws, regulations, rates and policies or competitive development including aggressive promotional activity from our competitors;

 

·                  the risk that we could experience deterioration in our current Star rating with the Centers of Medicare and Medicaid Services (“CMS”) or incur CMS penalties and/or sanctions;

 

·                  the nature, cost and outcome of pending and future litigation and other legal proceedings or governmental investigations, including any such proceedings related to the Merger or Sale and instituted against us and others;

 

·                  the potential reputational risk to our business during the period in which WBA is operating the Acquired Stores (as defined below) under the Rite Aid banner;

 

·                  the risk that the Tax Cuts and Jobs Act that was enacted on December 22, 2017 may have a negative impact on our financial results;

 

·                  the inability to fully realize the benefits of our tax attributes despite our entry into the Tax Benefits Preservation Plan;

 

·                  other risks and uncertainties described from time to time in our filings with the Securities and Exchange Commission (the “SEC”).

 

We undertake no obligation to update or revise the forward-looking statements included in this report, whether as a result of new information, future events or otherwise, after the date of this report. Our actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. Factors that could cause or contribute to such differences are discussed in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein and in our Annual Report on Form 10-K for the fiscal year ended March 4, 2017 (the “Fiscal 2017 10-K”), which we filed with the SEC on May 3, 2017, our Quarterly Report on Form 10-Q for the thirteen weeks ended June 3, 2017 (the “First Quarter 2018 10-Q”) which we filed on July 6, 2017, and our Quarterly Report on Form 10-Q for the thirteen weeks ended September 2, 2017 (the “Second Quarter 2018 10-Q”) which we filed on October 5, 2017, as well as in the “Risk Factors” section of the Fiscal 2017 10-K. These documents are available on the SEC’s website at www.sec.gov.

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1.  Financial Statements

 

RITE AID CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

(In thousands, except per share amounts)

 

(unaudited)

 

		December 2, 2017			March 4, 2017
ASSETS
Current assets:
Cash and cash equivalents		$	169,800		$	245,410
Accounts receivable, net		1,796,919			1,771,126
Inventories, net of LIFO reserve of $627,718 and $607,326		1,853,886			1,789,541
Prepaid expenses and other current assets		240,712			211,541
Current assets held for sale		1,868,128			1,047,670
Total current assets		5,929,445			5,065,288
Property, plant and equipment, net		1,479,214			1,526,462
Goodwill		1,682,847			1,682,847
Other intangibles, net		618,274			715,406
Deferred tax assets		1,419,544			1,505,564
Other assets		211,290			215,917
Noncurrent assets held for sale		—			882,268
Total assets		$	11,340,614		$	11,593,752
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt and lease financing obligations		$	20,354		$	17,709
Accounts payable		1,789,456			1,613,909
Accrued salaries, wages and other current liabilities		1,258,586			1,340,947
Current liabilities held for sale		3,837,519			32,683
Total current liabilities		6,905,915			3,005,248
Long-term debt, less current maturities		2,985,700			3,235,888
Lease financing obligations, less current maturities		31,654			37,204
Other noncurrent liabilities		592,201			643,950
Noncurrent liabilities held for sale		—			4,057,392
Total liabilities		10,515,470			10,979,682
Commitments and contingencies		—			—
Stockholders’ equity:
Common stock, par value $1 per share; 1,500,000 shares authorized; shares issued and outstanding 1,067,887 and 1,053,690		1,067,887			1,053,690
Additional paid-in capital		4,846,213			4,839,854
Accumulated deficit		(5,048,182		)	(5,237,157		)
Accumulated other comprehensive loss		(40,774		)	(42,317		)
Total stockholders’ equity		825,144			614,070
Total liabilities and stockholders’ equity		$	11,340,614		$	11,593,752

 

See accompanying notes to condensed consolidated financial statements.

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

(In thousands, except per share amounts)

 

(unaudited)

 

		Thirteen Week Period Ended
		December 2, 2017			November 26, 2016
Revenues		$	5,353,170		$	5,669,111
Costs and expenses:
Cost of revenues		4,166,447			4,424,259
Selling, general and administrative expenses		1,166,514			1,168,646
Lease termination and impairment charges		3,939			7,199
Interest expense		50,308			50,304
Loss (gain) on sale of assets, net		205			(225		)
		5,387,413			5,650,183
Loss (income) from continuing operations before income taxes		(34,243		)	18,928
Income tax benefit		(16,061		)	(4,682		)
Net (loss) income from continuing operations		(18,182		)	23,610
Net income (loss) from discontinued operations, net of tax		99,213			(8,600		)
Net income		$	81,031		$	15,010
Computation of (loss) income attributable to common stockholders:
(Loss) income from continuing operations attributable to common stockholders—basic and diluted		$	(18,182	)	$	23,610
Income (loss) from discontinued operations attributable to common stockholders—basic and diluted		99,213			(8,600		)
Income attributable to common stockholders—basic and diluted		$	81,031		$	15,010
Basic (loss) income per share:
Continuing operations		$	(0.02	)	$	0.02
Discontinued operations		$	0.10		$	(0.01	)
Net basic income per share		$	0.08		$	0.01
Diluted (loss) income per share:
Continuing operations		$	(0.02	)	$	0.02
Discontinued operations		$	0.10		$	(0.01	)
Net diluted income per share		$	0.08		$	0.01

 

See accompanying notes to condensed consolidated financial statements.

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

(In thousands)

 

(unaudited)

 

		Thirteen Week Period Ended
		December 2, 2017			November 26, 2016
Net income		$	81,031		$	15,010
Other comprehensive income:
Defined benefit pension plans:
Amortization of prior service cost, net transition obligation and net actuarial losses included in net periodic pension cost, net of $342 and $451 tax expense		514			681
Total other comprehensive income		514			681
Comprehensive income		$	81,545		$	15,691

 

See accompanying notes to condensed consolidated financial statements.

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

(In thousands, except per share amounts)

 

(unaudited)

 

		Thirty-Nine Week Period Ended
		December 2, 2017			November 26, 2016
Revenues		$	16,134,704		$	17,024,154
Costs and expenses:
Cost of revenues		12,624,365			13,308,505
Selling, general and administrative expenses		3,469,298			3,523,850
Lease termination and impairment charges		11,090			20,203
Interest expense		152,165			146,674
Walgreens Boots Alliance merger termination fee		(325,000		)	—
Gain on sale of assets, net		(20,623		)	(388		)
		15,911,295			16,998,844
Income from continuing operations before income taxes		223,409			25,310
Income tax expense (benefit)		89,268			(3,824		)
Net income from continuing operations		134,141			29,134
Net income (loss) from discontinued operations, net of tax		42,257			(3,939		)
Net income		$	176,398		$	25,195
Computation of income (loss) attributable to common stockholders:
Income from continuing operations attributable to common stockholders—basic and diluted		$	134,141		$	29,134
Income (loss) from discontinued operations attributable to common stockholders—basic and diluted		42,257			(3,939		)
Income attributable to common stockholders—basic and diluted		$	176,398		$	25,195
Basic income (loss) per share:
Continuing operations		$	0.13		$	0.03
Discontinued operations		$	0.04		$	(0.01	)
Net basic income per share		$	0.17		$	0.02
Diluted income (loss) per share:
Continuing operations		$	0.13		$	0.03
Discontinued operations		$	0.04		$	(0.01	)
Net diluted income per share		$	0.17		$	0.02

 

See accompanying notes to condensed consolidated financial statements.

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

(In thousands)

 

(unaudited)

 

		Thirty-Nine Week Period Ended
		December 2, 2017			November 26, 2016
Net income		$	176,398		$	25,195
Other comprehensive income:
Defined benefit pension plans:
Amortization of prior service cost, net transition obligation and net actuarial losses included in net periodic pension cost, net of $1,026 and $1,353 tax expense		1,543			2,043
Total other comprehensive income		1,543			2,043
Comprehensive income		$	177,941		$	27,238

 

See accompanying notes to condensed consolidated financial statements.

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(In thousands)

 

(unaudited)

 

		Thirty-Nine Week Period Ended
		December 2, 2017			November 26, 2016
Operating activities:
Net income		$	176,398		$	25,195
Net income (loss) from discontinued operations, net of tax		42,257			(3,939		)
Net income from continuing operations		$	134,141		$	29,134
Adjustments to reconcile to net cash provided by operating activities of continuing operations:
Depreciation and amortization		292,448			304,460
Lease termination and impairment charges		11,090			20,203
LIFO charge		20,393			25,266
Gain on sale of assets, net		(20,623		)	(388		)
Stock-based compensation expense		22,550			36,766
Changes in deferred taxes		98,597			6,165
Excess tax benefit on stock options and restricted stock		—			(3,809		)
Changes in operating assets and liabilities:
Accounts receivable		(19,865		)	(81,520		)
Inventories		(84,731		)	(128,568		)
Accounts payable		118,941			178,266
Other assets and liabilities, net		(148,491		)	(212,727		)
Net cash provided by operating activities of continuing operations		424,450			173,248
Investing activities:
Payments for property, plant and equipment		(140,816		)	(197,723		)
Intangible assets acquired		(20,201		)	(35,986		)
Proceeds from insured loss		3,627			—
Proceeds from dispositions of assets and investments		19,254			10,217
Net cash used in investing activities of continuing operations		(138,136		)	(223,492		)
Financing activities:
Net (payments to) proceeds from revolver		(264,080		)	280,000
Principal payments on long-term debt		(7,292		)	(12,728		)
Change in zero balance cash accounts		27,594			30,685
Net proceeds from issuance of common stock		4,416			4,412
Excess tax benefit on stock options and restricted stock		—			3,809
Payments for taxes related to net share settlement of equity awards		(4,103		)	(6,254		)
Net cash (used in) provided by financing activities of continuing operations		(243,465		)	299,924
Cash flows from discontinued operations:
Operating activities of discontinued operations		(62,294		)	(1,541		)
Investing activities of discontinued operations		189,175			(148,884		)
Financing activities of discontinued operations		(245,340		)	(3,698		)
Net cash used in discontinued operations		(118,459		)	(154,123		)
(Decrease) increase in cash and cash equivalents		(75,610		)	95,557
Cash and cash equivalents, beginning of period		245,410			124,471
Cash and cash equivalents, end of period		$	169,800		$	220,028

 

See accompanying notes to condensed consolidated financial statements.

 

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RITE AID CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

For the Thirteen and Thirty-Nine Week Periods Ended December 2, 2017 and November 26, 2016

 

(Dollars and share information in thousands, except per share amounts)

 

(unaudited)

 

1. Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X and therefore do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete annual financial statements. The accompanying financial information reflects all adjustments which are of a recurring nature and, in the opinion of management, are necessary for a fair presentation of the results for the interim periods. The results of operations for the thirteen and thirty-nine week periods ended December 2, 2017 are not necessarily indicative of the results to be expected for the full year. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Rite Aid Corporation (“Rite Aid”) and Subsidiaries (together with Rite Aid, the “Company”) Fiscal 2017 10-K.

 

The discussion and presentation of the operating and financial results of our business segments have been impacted by the following event.

 

On November 27, 2017, the Company announced that it had completed the pilot closing and first subsequent closing under the previously announced Amended and Restated Asset Purchase Agreement (the “Amended and Restated Asset Purchase Agreement” or the “Sale”), dated as of September 18, 2017, by and among the Company, WBA and Walgreen Co., an Illinois corporation and wholly owned direct subsidiary of WBA (“Buyer”). Based on its magnitude and because the Company is exiting certain markets, the Sale represents a significant strategic shift that has a material effect on the Company’s operations and financial results.  Accordingly, the Company has applied discontinued operations treatment for the Sale as required by Accounting Standards Codification 210-05 — Discontinued Operations (ASC 205-20).  In accordance with ASC 205-20, the Company reclassified the assets and liabilities to be sold, including 1,932 stores (the “Acquired Stores”), three (3) distribution centers, related inventory and other specified assets and liabilities related thereto (collectively the “Assets to be Sold” or “Disposal Group”) to assets and liabilities held for sale on its condensed consolidated balance sheets as of the periods ended December 2, 2017 and March 4, 2017, and reclassified the financial results of the Disposal Group in its condensed consolidated statements of operations and condensed consolidated statements of cash flows for all periods presented. Additionally, corporate support activities related to the Disposal Group were not reclassified to discontinued operations. Please see additional information as provided in Note 3 Asset Sale to WBA.

 

Recently Adopted Accounting Pronouncements

 

In March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation, (Topic 718): Improvements to Employee Share-Based Payment Accounting, which amends the accounting for certain aspects of share-based payments to employees in ASC Topic 718, Compensation — Stock Compensation. The new guidance eliminates the accounting for any excess tax benefits and deficiencies through equity and requires all excess tax benefits and deficiencies related to employee share-based compensation arrangements to be recorded in the income statement. This aspect of the new guidance is required to be applied prospectively. The new guidance also requires (i.) the presentation of excess tax benefits on the statement of cash flows as an operating activity rather than a financing activity, a change which may be applied prospectively or retrospectively and (ii.) the presentation of employee taxes paid when an employer withholds shares for tax withholding purposes on the statement of cash flows as a financing activity, a change which must be applied retrospectively. The new guidance further provides an accounting policy election to account for forfeitures as they occur rather than utilizing the estimated amount of forfeitures at the time of issuance. The Company adopted this new guidance effective March 5, 2017. The primary impact of adoption was (i.) the modified retrospective recognition of the cumulative amount of previously unrecognized excess tax benefits as an opening balance sheet adjustment and (ii.) the recognition of excess tax benefits in the income statement on a prospective basis, rather than equity. As a result, the Company (i.) increased the deferred tax asset and reduced accumulated deficit by $12,577 as of the beginning of the thirty-nine weeks ended December 2, 2017, and (ii.) the Company recognized a discrete income tax expense of $10,186 in income tax expense for the thirty-nine weeks ended December 2, 2017. The Company also elected to adopt the cash flow presentation of the excess tax benefits prospectively commencing in the first quarter of fiscal 2018. The retrospective application of cash paid on employees’ behalf related to shares withheld for tax purposes resulted in an increase to “Net cash provided by operating activities” and a decrease to “Net cash provided by financing activities” of $6,254 for the thirty-nine weeks ended November 26, 2016. The Company’s stock-based compensation expense continues to reflect estimated

 

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forfeitures. None of the other provisions in this new guidance had a material impact on the Company’s condensed consolidated financial statements.

 

Recently Issued Accounting Pronouncements Not Yet Adopted

 

In May 2015, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU removes inconsistencies, complexities and allows transparency and comparability of revenue transactions across entities, industries, jurisdictions and capital markets by providing a single comprehensive principles-based model with additional disclosures regarding uncertainties. The principles-based revenue recognition model has a five-step analysis of transactions to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606), an update to ASU 2014-09. This ASU amends ASU 2014-09 to defer the effective date by one year for annual reporting periods beginning after December 15, 2017 (fiscal 2019). Subsequently, the FASB has also issued accounting standards updates which clarify the guidance. Early adoption is permitted for annual reporting periods beginning after December 15, 2016 (fiscal 2018). In transition, the ASU may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption. The Company does not intend to early adopt the new standard. The Company assembled a cross functional team to identify the population of contracts with customers, for both its Retail Pharmacy and Pharmacy Services segments, and evaluate them under the provisions of ASU 2014-09. The Company intends to adopt the new standard on a modified retrospective basis. Under this implementation method, the Company will recognize the cumulative effect of initially applying the new guidance as an adjustment to the opening retained earnings balance for the annual reporting period of initial application. While the Company is continuing its assessment of all of the potential impacts of the new standard, it does not expect the implementation of the standard to have a material impact on the Company’s consolidated financial position, results of operations or cash flow.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases, (Topic 842), which is intended to improve financial reporting around leasing transactions. The ASU affects all companies and other organizations that engage in lease transactions (both lessee and lessor) that lease assets such as real estate and manufacturing equipment. This ASU will require organizations that lease assets—referred to as “leases”—to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. ASU No. 2016-02 is effective for fiscal years and interim periods within those years beginning January 1, 2019 (fiscal 2020). During its November 29, 2017 meeting, the FASB tentatively decided to amend certain aspects of the new leasing standard. The tentative amendments include a provision to allow entities to elect not to restate comparative periods in the period of adoption when transitioning to the new standard. The Company believes that the new standard will have a material impact on its financial position. The Company is currently evaluating the impact this standard implementation will have on its results of operations and cash flows.

 

In January 2017, the FASB issued ASU No. 2017-04, Intangibles—Goodwill and Other, (Topic 350): Simplifying the Test for Goodwill Impairment, which is intended to simplify the subsequent measurement and impairment of goodwill. The ASU simplifies the complexity of evaluating goodwill for impairment by eliminating the second step of the impairment test, which compares the implied fair value of a reporting unit’s goodwill to the carrying amount of that goodwill. Instead, the ASU requires entities to compare the fair value of a reporting unit to its carrying amount in order to determine the amount of goodwill impairment recognized. ASU No. 2017-04 is effective for fiscal years and interim periods within those years beginning after December 15, 2019 (fiscal 2020). Early adoption of all the amendments for ASU 2017-04 is permitted. Amendments must be applied prospectively. The Company is in process of assessing the impact of the adoption of ASU No. 2017-04 on its financial position, results of operations and cash flows.

 

2. Acquisition

 

On June 24, 2015, the Company acquired TPG VI Envision BL, LLC and Envision Topco Holdings, LLC (“EnvisionRx”), pursuant to the terms of an agreement (“Agreement”) dated February 10, 2015 (the “Acquisition”). EnvisionRx, which has been rebranded as EnvisionRxOptions (“EnvisionRx” or “EnvisionRxOptions”), is a full-service pharmacy services provider. EnvisionRx provides both transparent and traditional pharmacy benefit manager (“PBM”) service options through its EnvisionRx and MedTrak PBMs, respectively. EnvisionRx also offers fully integrated mail-order and specialty pharmacy services through EnvisionPharmacies; access to the nation’s largest cash pay infertility discount drug program via Design Rx; an innovative claims adjudication software platform in Laker Software; and a national Medicare Part D prescription drug plan through Envision Insurance Company’s (“EIC”) EnvisionRx Plus Silver product for the low income auto-assign market and its Clear Choice product for the chooser market. EnvisionRx is headquartered in Twinsburg, Ohio and operates as a 100 percent owned subsidiary of the Company.

 

Pursuant to the terms of the Agreement, as consideration for the Acquisition, the Company paid $1,882,211 in cash and issued 27,754 shares of Rite Aid common stock. The Company financed the cash portion of the Acquisition with borrowings under its Amended and Restated Senior Secured Revolving Credit Facility, and the net proceeds from the April 2, 2015 issuance of $1,800,000 aggregate principal amount of 6.125% senior notes due 2023 (the “6.125% Notes”). The consideration associated with the common

 

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stock was $240,907 based on a stock price of $8.68 per share, representing the closing price of the Company’s common stock on the closing date of the Acquisition.

 

The Company’s condensed consolidated financial statements for the thirteen and thirty-nine week periods ended December 2, 2017 and November 26, 2016 include EnvisionRx results of operations (please see Note 13 Segment Reporting for the Pharmacy Services segment results included within the condensed consolidated financial statements for the thirteen and thirty-nine week periods ended December 2, 2017 and November 26, 2016, which reflects the results of EnvisionRx). The Company’s condensed consolidated financial statements reflect the purchase accounting adjustments in accordance with ASC 805 “Business Combinations”, whereby the purchase price was allocated to the assets acquired and liabilities assumed based upon their estimated fair values on the Acquisition date.

 

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During fiscal 2017, the Company finalized the valuation of the identifiable assets acquired and the liabilities assumed. The following is the allocation of the purchase price:

 

Final purchase price
Cash consideration		$	1,882,211
Stock consideration		240,907
Total		$	2,123,118
Final purchase price allocation
Cash and cash equivalents		$	103,834
Accounts receivable		892,678
Inventories		7,276
Prepaid expenses and other current assets		13,386
Total current assets		1,017,174
Property and equipment		13,196
Intangible assets(1)		646,600
Goodwill		1,639,355
Other assets		7,219
Total assets acquired		3,323,544
Accounts payable		491,672
Reinsurance funds held		381,225
Other current liabilities(2)		215,770
Total current liabilities		1,088,667
Other long term liabilities(3)		111,759
Total liabilities assumed		1,200,426
Net assets acquired		$	2,123,118

 

(1)                                 Intangible assets are recorded at estimated fair value, as determined by management based on available information which includes a final valuation prepared by an independent third party. The fair values assigned to identifiable intangible assets were determined through the use of the income approach, specifically the relief from royalty and the multi-period excess earnings methods. The major assumptions used in arriving at the estimated identifiable intangible asset values included management’s estimates of future cash flows, discounted at an appropriate rate of return which are based on the weighted average cost of capital for both the Company and other market participants, projected customer attrition rates, as well as applicable royalty rates for comparable assets. The useful lives for intangible assets were determined based upon the remaining useful economic lives of the intangible assets that are expected to contribute directly or indirectly to future cash flows. The estimated fair value of intangible assets and related useful lives as included in the final purchase price allocation include:

 

		Estimated Fair Value			Estimated Useful Life (In Years)
Customer relationships		$	465,000		17
CMS license		57,500			25
Claims adjudication and other developed software		59,000			7
Trademarks		20,100			10
Backlog		11,500			3
Trademarks		33,500			Indefinite
Total		$	646,600

 

(2)                                 Other current liabilities includes $116,057 due to TPG under the terms of the Agreement, representing the amounts due to EnvisionRx from CMS, less corresponding amounts due to various reinsurance providers under certain reinsurance programs, for CMS activities that relate to the year ended December 31, 2014. This liability was satisfied with a payment to TPG on November 5, 2015.

 

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(3)                                 Primarily relates to deferred tax liabilities.

 

The above goodwill represents future economic benefits expected to be recognized from the Company’s expansion into the pharmacy services market, as well as expected future synergies and operating efficiencies from combining operations with EnvisionRx. Goodwill resulting from the Acquisition of $1,639,355 has been allocated to the Pharmacy Services segment of which $1,368,657 is deductible for tax purposes.

 

3. Asset Sale to WBA

 

Termination of Merger Agreement with WBA

 

On June 28, 2017, Rite Aid, WBA and Victoria Merger Sub, Inc. entered into a Termination Agreement (the “Merger Termination Agreement”) under which the parties agreed to terminate the Merger Agreement.  The Merger Termination Agreement provides that WBA would pay to Rite Aid a termination fee in the amount of $325,000, which was received on June 30, 2017.

 

Entry Into Amended and Restated Asset Purchase Agreement with WBA

 

On September 18, 2017, the Company entered into the Amended and Restated Asset Purchase Agreement with WBA and Buyer, which amended and restated in its entirety the previously disclosed Asset Purchase Agreement (the “Original APA”), dated as of June 28, 2017, by and among the Company, WBA and Buyer.  Pursuant to the terms and subject to the conditions set forth in the Amended and Restated Asset Purchase Agreement, Buyer will purchase from the Company 1,932 stores (the “Acquired Stores”), three (3) distribution centers, related inventory and other specified assets and liabilities related thereto (collectively the “Assets to be Sold” or “Disposal Group”) for a purchase price of approximately $4.375 billion, on a cash-free, debt-free basis (the “Sale”).

 

The Company announced on September 19, 2017 that the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the “HSR Act”), expired with respect to the Sale.  On November 27, 2017, the Company announced that it had completed the pilot closing and first subsequent closings under the Amended and Restated Asset Purchase Agreement, resulting in the transfer of 97 Rite Aid stores and related assets to the Buyer. With the final significant closing condition met, and the successful completion of the of the pilot closing and the first subsequent closings, the Sale will proceed as contemplated under the Amended and Restated Asset Purchase Agreement.  The Sale remains subject to minimal customary closing conditions applicable only to individual stores being transferred at such subsequent closings, as specified in the Amended and Restated Asset Purchase Agreement.

 

The parties to the Amended and Restated Asset Purchase Agreement have each made customary representations and warranties. The Company has agreed to various covenants and agreements, including, among others, the Company’s agreement to conduct its business at the Acquired Stores in the ordinary course during the period between the execution of the Amended and Restated Asset Purchase Agreement and the subsequent closings.  The Company has also agreed to provide transition services to Buyer for up to three (3) years after the initial closing of the Sale.  During the thirteen week period ended December 2, 2017, the amount charged to Buyer for transition services was nominal.

 

In the event that the Company enters into an agreement to sell all of the remainder of Rite Aid or over 50% of its stock or assets to a third party prior to the end of the transition period under the Transition Services Agreement (“TSA”), any potential acquirer would be obligated to assume the Company’s remaining obligations under the TSA.  Under the terms of the Amended and Restated Asset Purchase Agreement, the Company has the option to purchase pharmaceutical drugs through an affiliate of WBA under terms, including cost, that are substantially equivalent to Walgreen’s for a period of ten (10) years, subject to certain terms and conditions.

 

Divestiture of the Assets to be Sold

 

During the thirteen weeks ended December 2, 2017, the Company sold 97 stores and related assets to the Buyer in exchange for proceeds of $240,920, and recognized a pre-tax gain of approximately $157,010.  During December 2017, the Company sold an additional 260 stores and related assets to WBA for proceeds of $473,980. The Company estimates that the total pre-tax gain on the Sale will be approximately $2.5 billion.  The Company expects to complete the majority of the Sale by the end of its first quarter of fiscal 2019.

 

The Company classified the operating results of the Disposal Group as discontinued operations in its financial statements in accordance with GAAP, as the divestiture of these assets represents a significant strategic shift that has a material effect on the Company’s operations and financial results.

 

The carrying amount of the Assets to be Sold, which were included in the Retail Pharmacy segment, have been reclassified from their historical balance sheet presentation to current and non-current assets and liabilities held for sale as follows:

 

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		December 2, 2017			March 4, 2017
Inventories		$	1,071,253		$	1,047,670
Property and equipment		666,118			—
Goodwill (a)		30,994			—
Intangible assets		96,461			—
Other assets		3,302			—
Current assets held for sale		$	1,868,128		$	1,047,670
Property and equipment		$	—		$	725,230
Goodwill (a)		—			32,632
Intangible assets		—			120,389
Other assets		—			4,017
Noncurrent assets held for sale		$	—		$	882,268
Current maturities of long-term lease financing obligations		$	1,908		$	3,626
Accrued salaries, wages and other current liabilities		24,020			29,057
Long-term debt, less current maturities (b)		3,786,480			—
Lease financing obligations, less current maturities		4,164			—
Other noncurrent liabilities		20,947			—
Current liabilities held for sale		$	3,837,519		$	32,683
Long-term debt, less current maturities (b)		$	—		$	4,027,400
Lease financing obligations, less current maturities		—			6,866
Other noncurrent liabilities		—			23,126
Noncurrent liabilities held for sale		$	—		$	4,057,392

 

(a)         The Company had $76,124 of goodwill in its Retail Pharmacy segment resulting from the acquisition of Health Dialog and RediClinic, which is accounted for as Retail Pharmacy segment enterprise goodwill.  The Company has allocated a portion of its Retail Pharmacy segment enterprise goodwill to the discontinued operation.

 

(b)         In connection with the Sale, the Company is estimating that the Sale will provide excess cash proceeds of approximately $4,027,400 which will be used to repay outstanding indebtedness.  As such, the $4,027,400 of estimated repayment of outstanding indebtedness has been included in liabilities held for sale as of March 4, 2017. As of December 2, 2017, the Company repaid outstanding indebtedness of $240,920 with transaction proceeds received.

 

The operating results of the discontinued operations that are reflected on the unaudited condensed consolidated statements of operations within net income (loss) from discontinued operations are as follows:

 

		Thirteen Week Period Ended						Thirty-Nine Week Period Ended
		December 2, 2017			November 26, 2016			December 2, 2017			November 26, 2016
Revenues		$	2,386,710		$	2,452,996		$	7,130,653		$	7,376,859
Costs and expenses:
Cost of revenues(a)		1,752,664			1,802,987			5,274,187			5,386,605
Selling, general and administrative expenses(a)		572,809			605,216			1,765,621			1,821,506
Lease termination and impairment charges		11			66			74			76
Interest expense (b)		59,456			56,006			178,797			170,136
Gain on stores sold to Walgreens Boots Alliance		(157,010		)	—			(157,010		)	—
(Gain) loss on sale of assets, net		(589		)	726			23			2,119
		2,227,341			2,465,001			7,061,692			7,380,442
Income (loss) from discontinued operations before income taxes		159,369			(12,005		)	68,961			(3,583		)
Income tax expense (benefit)		60,155			(3,405		)	26,705			356
Net income (loss) from discontinued operations, net of tax		$	99,213		$	(8,600	)	$	42,257		$	(3,939	)

 

(a)                                 Cost of revenues and selling, general and administrative expenses for the discontinued operations excludes corporate overhead.  These charges are reflected in continuing operations.

 

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(b)                                 In accordance with ASC 205-20, the operating results for the thirteen and thirty-nine week periods ended December 2, 2017 and November 26, 2016 for the discontinued operations include interest expense relating to the $4,027,400 of outstanding indebtedness expected to be repaid with the estimated excess proceeds from the Sale.

 

The operating results reflected above do not fully represent the Disposal Group’s historical operating results, as the results reported within net income from discontinued operations only include expenses that are directly attributable to the Disposal Group.

 

The Company will continue to generate pharmacy services revenue from the Disposal Group after the Sale is completed.  As such, the Company has increased revenues and cost of revenues of the continuing operations to reflect amounts that were previously eliminated in consolidation relating to intercompany sales between the Company and the Disposal Group.  Accordingly, the Company has not eliminated $32,381 and $97,301 from revenues and cost of revenues for the thirteen and thirty-nine week periods ended November 26, 2016.  Please refer to Note 13 Segment Reporting for the impact on the thirteen and thirty-nine week periods ended December 2, 2017.

 

4. (Loss) Income Per Share

 

Basic (loss) income per share is computed by dividing income available to common stockholders by the weighted average number of shares of common stock outstanding for the period. Diluted (loss) income per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the income of the Company subject to anti-dilution limitations.

 

		Thirteen Week Period Ended						Thirty-Nine Week Period Ended
		December 2,  2017			November 26,  2016			December 2,  2017			November 26,  2016
Basic and diluted (loss) income per share:
Numerator:
Net (loss) income from continuing operations		$	(18,182	)	$	23,610		$	134,141		$	29,134
Net income (loss) from discontinued operations, net of tax		99,213			(8,600		)	42,257			(3,939		)
Income (loss) attributable to common stockholders basic and diluted		$	81,031		$	15,010		$	176,398		$	25,195
Denominator:
Basic weighted average shares		1,048,502			1,045,028			1,048,342			1,043,887
Outstanding options and restricted shares, net		7,367			15,735			18,948			17,117
Diluted weighted-average shares		1,055,869			1,060,763			1,067,290			1,061,004
Basic and diluted (loss) earnings per share:
Continuing operations		$	(0.02	)	$	0.02		$	0.13		$	0.03
Discontinued operations		0.10			(0.01		)	0.04			(0.01		)
Net earnings per share		$	0.08		$	0.01		$	0.17		$	0.02

 

Due to their antidilutive effect, 9,861 and 3,320 potential common shares related to stock options have been excluded from the computation of diluted income per share for the thirteen week period ended December 2, 2017 and November 26, 2016, respectively. Due to their antidilutive effect, 5,195 and 3,320 potential common shares related to stock options have been excluded

 

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from the computation of diluted income per share for the thirty-nine week period ended December 2, 2017 and November 26, 2016, respectively.

 

5. Lease Termination and Impairment Charges

 

Lease termination and impairment charges consist of amounts as follows:

 

		Thirteen Week Period Ended						Thirty-Nine Week Period Ended
		December 2, 2017			November 26, 2016			December 2, 2017			November 26, 2016
Impairment charges		$	315		$	890		$	946		$	1,578
Lease termination charges		3,624			6,309			10,144			18,625
		$	3,939		$	7,199		$	11,090		$	20,203

 

Impairment Charges

 

These amounts include the write-down of long-lived assets at locations that were assessed for impairment because of management’s intention to relocate or close the location or because of changes in circumstances that indicated the carrying value of an asset may not be recoverable.

 

Lease Termination Charges

 

As part of the Company’s ongoing business activities, the Company assesses stores and distribution centers for potential closure or relocation. Decisions to close or relocate stores or distribution centers in future periods would result in lease termination charges, lease exit costs and inventory liquidation charges, 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:

 

		Thirteen Week Period Ended						Thirty-Nine Week Period Ended
		December 2, 2017			November 26, 2016			December 2, 2017			November 26, 2016
Balance—beginning of period		$	144,011		$	190,708		$	165,138		$	208,421
Provision for present value of noncancellable lease payments of closed stores		1,138			2,725			2,051			5,877
Changes in assumptions about future sublease income,  terminations and changes in interest rates		(264		)	137			(612		)	2,044
Interest accretion		2,776			3,482			8,778			10,878
Cash payments, net of sublease income		(11,800		)	(17,073		)	(39,494		)	(47,241		)
Balance—end of period		$	135,861		$	179,979		$	135,861		$	179,979

 

6. Fair Value Measurements

 

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.

 

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Non-Financial Assets Measured on a Non-Recurring Basis

 

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. During the thirty-nine week period ended December 2, 2017, long-lived assets from continuing operations with a carrying value of $1,224, primarily store assets, were written down to their fair value of $278, resulting in an impairment charge of $946 of which $315 relates to the thirteen week period ended December 2, 2017. During the thirty-nine week period ended November 26, 2016, long-lived assets from continuing operations with a carrying value of $3,309, primarily store assets, were written down to their fair value of $1,731, resulting in an impairment charge of $1,578 of which $890 relates to the thirteen week period ended November 26, 2016.   If our actual future cash flows differ from our projections materially, certain stores that are either not impaired or partially impaired in the current period may be further impaired in future periods.

 

The following table presents fair values for those assets measured at fair value on a non-recurring basis at December 2, 2017 and November 26, 2016:

 

Fair Value Measurement Using

 

		Level 1			Level 2			Level 3			Total as of December 2, 2017
Long-lived assets held for use		$	—		$	—		$	174		$	174
Long-lived assets held for sale		$	—		$	104		$	—		$	104
Total		$	—		$	104		$	174		$	278

 

		Level 1			Level 2			Level 3			Total as of November 26, 2016
Long-lived assets held for use		$	—		$	—		$	708		$	708
Long-lived assets held for sale		$	—		$	1,023		$	—		$	1,023
Total		$	—		$	1,023		$	708		$	1,731

 

The above assets reflected in the caption Long-lived assets held for sale are separate and apart from the Assets to be Sold and do to their immateriality have not been reclassified to assets held for sale.

 

As of December 2, 2017 and November 26, 2016, the Company did not have any financial assets measured on a recurring basis.

 

Other Financial Instruments

 

Financial instruments other than long-term indebtedness include cash and cash equivalents, accounts receivable and accounts payable. These instruments are recorded at book value, which we believe approximate their fair values due to their short term nature.  In addition, as of December 2, 2017 the Company has $7,295 of investments, carried at amortized cost as these investments are being held to maturity, which are included as a component of other assets.  As of March 4, 2017 the Company has $6,874 of investments, carried at amortized cost as these investments are being held to maturity, which are included as a component of prepaid expenses and other current assets.  The Company believes the carrying value of these investments approximates their fair value.

 

The fair value for LIBOR-based borrowings under the Company’s senior secured credit facility and first and second lien term loans are estimated based on the quoted market price of the financial instrument which is considered Level 1 of the fair value hierarchy. The fair values of substantially all of the Company’s other long-term indebtedness are estimated based on quoted market prices of the financial instruments which are considered Level 1 of the fair value hierarchy. The carrying amount and estimated fair value of the Company’s total long-term indebtedness was $6,772,270 and $6,588,733, respectively, as of December 2, 2017. There were no outstanding derivative financial instruments as of December 2, 2017 and March 4, 2017.

 

7. Income Taxes

 

The Company recorded an income tax benefit of $16,061 and $4,682 for the thirteen week periods ended December 2, 2017 and November 26, 2016, respectively, and an income tax expense of $89,268 and an income tax benefit of $3,824 for the thirty-nine week periods ended December 2, 2017 and November 26, 2016, respectively.  The effective tax rate for the thirteen week periods

 

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ended December 2, 2017 and November 26, 2016 was 46.9% and (24.7)%, respectively.  The effective tax rate for the thirty-nine week periods ended December 2, 2017 and November 26, 2016 was 40.0% and (15.1)%, respectively.  The effective tax rate for the thirteen and thirty-nine week periods ended December 2, 2017 includes an adjustment of 13% and 1%, respectively, for changes to the valuation allowance primarily relating to state NOLs.  The effective tax rate for the thirty-nine week period ended December 2, 2017 also includes an adjustment of 55%, primarily related to the tax impact of the Walgreens Boots Alliance merger termination fee received in the second quarter of fiscal 2018. The tax benefit for the thirteen and thirty-nine week periods ended November 26, 2016 was the result of lower projected earnings for the Retail Pharmacy segment which resulted in a cumulative adjustment to the annual effective tax rate.

 

The Company recognizes tax liabilities in accordance with the guidance for uncertain tax positions and management adjusts these liabilities with changes in judgment as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from the current estimate of the tax liabilities.

 

While it is expected that the amount of unrecognized tax benefits will change in the next twelve months, the Company does not expect the change to have a significant impact on the results of operations or the financial position of the Company.

 

The Company regularly evaluates valuation allowances established for deferred tax assets for which future realization is uncertain.  Management will continue to monitor all available evidence related to the net deferred tax assets that may change the most recent assessment, including events that have occurred or are anticipated to occur. The Company continues to maintain a valuation allowance against net deferred tax assets of $826,798 and $226,726, which relates primarily to state deferred tax assets at December 2, 2017 and March 4, 2017, respectively.  The increase in valuation allowance for the period December 2, 2017 relates primarily to a Pennsylvania law change which required an increase to the state deferred tax asset for certain net operating losses with an offsetting valuation allowance adjustment.

 

On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act into legislation.  The Company expects to record a tax expense in the fourth quarter of fiscal 2018 between $200,000 and $325,000, primarily due to the re-measurement of its net deferred tax assets.

 

8. Medicare Part D

 

The Company offers Medicare Part D benefits through EIC, which has contracted with Centers of Medicare and Medicaid Services (“CMS”) to be a Prescription Drug Plan (“PDP”) and, pursuant to the Medicare Prescription Drug, Improvement and Modernization Act of 2003, must be a risk-bearing entity regulated under state insurance laws or similar statutes.

 

EIC is a licensed domestic insurance company under the applicable laws and regulations. Pursuant to these laws and regulations, EIC must file quarterly and annual reports with the National Association of Insurance Commissioners (“NAIC”) and certain state regulators, must maintain certain minimum amounts of capital and surplus under formulas established by certain states and must, in certain circumstances, request and receive the approval of certain state regulators before making dividend payments or other capital distributions to the Company. The Company does not believe these limitations on dividends and distributions materially impact its financial position. EIC is subject to minimum capital and surplus requirements in certain states. The minimum amount of capital and surplus required to satisfy regulatory requirements in these states is $36,426 as of September 30, 2017. EIC was in excess of the minimum required amounts in these states as of December 2, 2017.

 

The Company has recorded estimates of various assets and liabilities arising from its participation in the Medicare Part D program based on information in its claims management and enrollment systems. Significant estimates arising from its participation in this program include: (i) estimates of low-income cost subsidies, reinsurance amounts, and coverage gap discount amounts ultimately payable to CMS based on a detailed claims reconciliation that will occur in the following year; (ii) an estimate of amounts receivable from CMS under a risk-sharing feature of the Medicare Part D program design, referred to as the risk corridor and (iii) estimates for claims that have been reported and are in the process of being paid or contested and for our estimate of claims that have been incurred but have not yet been reported.

 

As of December 2, 2017, accounts receivable, net included $279,148 due from CMS and accrued salaries, wages and other current liabilities included $130,211 of EIC liabilities under certain reinsurance contracts. As of March 4, 2017, accounts receivable, net included $245,766 due from CMS and accrued salaries, wages and other current liabilities included $145,903 of EIC liabilities under certain reinsurance contracts. During calendar 2017, EIC limited its exposure to loss and recovers a portion of benefits paid by utilizing quota-share reinsurance with a commercial reinsurance company.

 

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9. Goodwill and Other Intangible Assets

 

Goodwill and indefinitely-lived assets, such as certain trademarks acquired in connection with acquisition transactions, are not amortized, but are instead evaluated for impairment on an annual basis at the end of the fiscal year, or more frequently if events or circumstances indicate that impairment may be more likely. During the thirteen and thirty-nine weeks ended December 2, 2017 and the fifty-three weeks ended March 4, 2017, no impairment charges have been taken against the Company’s goodwill or indefinitely-lived intangible assets. No changes were made to the carrying amount of goodwill for the thirteen and thirty-nine week periods ended December 2, 2017.

 

The Company’s intangible assets are primarily finite-lived and amortized over their useful lives. Following is a summary of the Company’s finite-lived and indefinite-lived intangible assets as of December 2, 2017 and March 4, 2017.

 

		December 2, 2017											March 4, 2017
		Gross Carrying Amount			Accumulated Amortization			Net			Remaining Weighted Average Amortization Period		Gross Carrying Amount			Accumulated Amortization			Net			Remaining Weighted Average Amortization Period
Favorable leases and other (a)		$	384,937		$	(318,634	)	$	66,303		7 years		$	386,636		$	(308,766	)	$	77,870		7 years
Prescription files		898,351			(795,003		)	103,348			3 years		894,330			(764,840		)	129,490			3 years
Customer relationships(a)		465,000			(157,639		)	307,361			15 years		465,000			(110,653		)	354,347			16 years
CMS license		57,500			(5,597		)	51,903			23 years		57,500			(3,872		)	53,628			24 years
Claims adjudication and other developed software		58,987			(20,509		)	38,478			5 years		58,995			(14,188		)	44,807			6 years
Trademarks		20,100			(4,891		)	15,209			8 years		20,100			(3,383		)	16,717			9 years
Backlog		11,500			(9,328		)	2,172			1 year		11,500			(6,453		)	5,047			2 years
Total finite		$	1,896,375		$	(1,311,601	)	$	584,774				$	1,894,061		$	(1,212,155	)	$	681,906
Trademarks		33,500			—			33,500			Indefinite		33,500			—			33,500			Indefinite
Total		$	1,929,875		$	(1,311,601	)	$	618,274				$	1,927,561		$	(1,212,155	)	$	715,406

 

(a)                                   Amortized on an accelerated basis which is determined based on the remaining useful economic lives of the customer relationships that are expected to contribute directly or indirectly to future cash flows.

 

Also included in other non-current liabilities as of December 2, 2017 and March 4, 2017 are unfavorable lease intangibles with a net carrying amount of $20,740 and $23,703, respectively. These intangible liabilities are amortized over their remaining lease terms at the time of acquisition.  Included in noncurrent liabilities held for sale as of December 2, 2017 and March 4, 2017 are unfavorable lease intangibles with a net carrying amount of $13,394 and $14,539, respectively.

 

Amortization expense for these intangible assets and liabilities was $35,490 and $112,772 for the thirteen and thirty-nine week periods ended December 2, 2017, respectively. Amortization expense for these intangible assets and liabilities was $41,654 and $124,060 for the thirteen and thirty-nine week periods ended November 26, 2016, respectively. The anticipated annual amortization expense for these intangible assets and liabilities is 2018—$172,501; 2019—$120,319; 2020—$96,399; 2021—$72,519 and 2022—$50,715.

 

10. Indebtedness and Credit Agreements

 

Following is a summary of indebtedness and lease financing obligations at December 2, 2017 and March 4, 2017:

 

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