UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
MARK ONE
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR QUARTER ENDED JUNE 17, 2006
OR
[_] 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 1-4141
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
(Exact name of registrant as specified in charter)
MARYLAND 13-1890974
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2 PARAGON DRIVE
MONTVALE, NEW JERSEY 07645
(Address of principal executive offices)
(201) 573-9700
Registrant's telephone number, including area code
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 (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS. YES [X] NO [_]
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT. YES [X] NO [_]
AS OF JULY 19, 2006 THE REGISTRANT HAD A TOTAL OF 41,449,737 SHARES OF COMMON
STOCK - $1 PAR VALUE OUTSTANDING.
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except share and per share amounts)
(Unaudited)
16 Weeks Ended
-----------------------------
June 17, 2006 June 18, 2005
------------- -------------
Sales $ 2,126,895 $ 3,383,633
Cost of merchandise sold (1,488,744) (2,445,675)
----------- -----------
Gross margin 638,151 937,958
Store operating, general and administrative expense (643,204) (976,098)
----------- -----------
Loss from operations (5,053) (38,140)
Loss on sale of Canadian operations (326) (589)
Interest expense (22,156) (36,123)
Interest income 4,503 1,186
Minority interest in losses of consolidated franchisees -- (1,536)
Equity in earnings of Metro, Inc. 7,947 --
----------- -----------
Loss from continuing operations before income taxes (15,085) (75,202)
Benefit from (provision for) income taxes 9,659 (13,936)
----------- -----------
Loss from continuing operations (5,426) (89,138)
Discontinued operations:
Loss from operations of discontinued businesses, net of tax benefit of
$0 and $71 for the 16 weeks ended June 17, 2006 and June 18, 2005,
respectively (683) (97)
----------- -----------
Loss from discontinued operations (683) (97)
----------- -----------
Net loss $ (6,109) $ (89,235)
=========== ===========
Net loss per share - basic and diluted:
Continuing operations $ (0.13) $ (2.27)
Discontinued operations (0.02) (0.01)
----------- -----------
Net loss per share - basic and diluted $ (0.15) $ (2.28)
=========== ===========
Weighted average number of common shares outstanding 41,280,600 39,201,114
Common stock equivalents 558,704 609,775
----------- -----------
Weighted average number of common and common equivalent
shares outstanding 41,839,304 39,810,889
=========== ==========
See Notes to Quarterly Report
2
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands, except share and per share amounts)
(Unaudited)
Retained Accumulated
Common Stock Additional Earnings Other Total
-------------------- Paid-in (Accumulated Comprehensive Stockholders'
Shares Amount Capital Deficit) Income (Loss) Equity
---------- ------- ---------- ------------ ------------- -------------
16 WEEK PERIOD ENDED
JUNE 17, 2006
Balance at beginning of period 41,148,987 $41,149 $497,193 $ 126,432 $ 6,953 $671,727
Net loss (6,109) (6,109)
Other comprehensive income 11,415 11,415
Cash dividends on common stock -
$7.25 per share (299,089) (299,089)
Stock options exercised 295,298 295 4,307 4,602
Other share based awards 3,337 3,337
---------- ------- -------- --------- ------- --------
Balance at end of period 41,444,285 $41,444 $205,748 $ 120,323 $18,368 $385,883
========== ======= ======== ========= ======= ========
16 WEEK PERIOD ENDED
JUNE 18, 2005
Balance at beginning of period 38,764,999 $38,765 $464,543 $(266,198) $(3,308) $233,802
Net loss (89,235) (89,235)
Other comprehensive loss (4,020) (4,020)
Stock options exercised 1,255,170 1,255 10,632 11,887
Other share based awards 2,140 2,140
---------- ------- -------- --------- ------- --------
Balance at end of period 40,020,169 $40,020 $477,315 $(355,433) $(7,328) $154,574
========== ======= ======== ========= ======= ========
COMPREHENSIVE INCOME (LOSS)
16 Weeks Ended
-----------------------------
June 17, 2006 June 18, 2005
------------- -------------
Net loss $(6,109) $(89,235)
------- --------
Foreign currency translation adjustment 11,529 (3,963)
Net unrealized loss on marketable securities, net of tax (114) --
Net unrealized loss on derivatives, net of tax -- (57)
------- --------
Other comprehensive income (loss), net of tax 11,415 (4,020)
------- --------
Total comprehensive income (loss) $ 5,306 $(93,255)
======= ========
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) BALANCES
Net Unrealized Accumulated
Foreign Loss on Net Unrealized Minimum Other
Currency Marketable Gain / (Loss) Pension Comprehensive
Translation Securities on Derivatives Liability Income (Loss)
----------- -------------- -------------- --------- --------------
Balance at February 25, 2006 $12,874 $(1,015) $ -- $(4,906) $ 6,953
Current period change 11,529 (114) -- -- 11,415
------- ------- ---- ------- -------
Balance at June 17, 2006 $24,403 $(1,129) $ -- $(4,906) $18,368
======= ======= ==== ======= =======
Balance at February 26, 2005 3,035 -- 57 (6,400) (3,308)
Current period change (3,963) -- (57) -- (4,020)
------- ------- ---- ------- -------
Balance at June 18, 2005 $ (928) $ -- $ -- $(6,400) $(7,328)
======= ======= ==== ======= =======
See Notes to Quarterly Report
3
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands except share amounts)
June 17, 2006 February 25, 2006
------------- -----------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 97,021 $ 229,589
Restricted cash 69,482 146,309
Restricted marketable securities 95,908 --
Marketable securities -- 167,405
Accounts receivable, net of allowance for doubtful accounts of
$5,743 and $7,042 at June 17, 2006 and February 25, 2006,
respectively 135,871 175,939
Inventories 402,015 405,310
Prepaid expenses and other current assets 80,428 85,462
---------- ----------
Total current assets 880,725 1,210,014
---------- ----------
Non-current assets:
Property:
Property owned 884,871 875,140
Property leased under capital leases, net 22,307 23,094
---------- ----------
Property - net 907,178 898,234
Equity investment in Metro, Inc. 356,486 338,756
Other assets 51,998 51,861
---------- ----------
Total assets $2,196,387 $2,498,865
========== ==========
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 32,402 $ 569
Current portion of obligations under capital leases 1,977 2,274
Accounts payable 211,540 209,774
Book overdrafts 43,059 35,447
Accrued salaries, wages and benefits 102,213 121,734
Accrued taxes 34,870 34,215
Other accruals 158,923 206,260
---------- ----------
Total current liabilities 584,984 610,273
---------- ----------
Non-current liabilities:
Long-term debt 284,772 246,282
Long-term obligations under capital leases 31,812 32,270
Long-term real estate liabilities 296,533 297,453
Other non-current liabilities 612,403 640,860
---------- ----------
Total liabilities 1,810,504 1,827,138
---------- ----------
Commitments and contingencies
Stockholders' equity:
Preferred stock--no par value; authorized - 3,000,000 shares;
issued - none -- --
Common stock--$1 par value; authorized - 80,000,000 shares;
issued and outstanding - 41,444,285 and 41,148,987 shares
at June 17, 2006 and February 25, 2006, respectively 41,444 41,149
Additional paid-in capital 205,748 497,193
Accumulated other comprehensive income 18,368 6,953
Retained earnings 120,323 126,432
---------- ----------
Total stockholders' equity 385,883 671,727
---------- ----------
Total liabilities and stockholders' equity $2,196,387 $2,498,865
========== ==========
See Notes to Quarterly Report
4
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
16 Weeks Ended
-----------------------------
June 17, 2006 June 18, 2005
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (6,109) $(89,235)
Adjustments to reconcile net loss to net cash provided by operating activities:
Asset disposition initiatives 7,251 63,121
Depreciation and amortization 54,947 71,875
Income tax benefit relating to the sale of our Canadian operations (11,300) --
Deferred income tax provision -- 5,430
Gain on disposal of owned property and write-down of property, net (9,676) (15,352)
Other property impairments 1,221 506
Loss on sale of Canadian operations 326 589
Other share based awards 3,337 2,140
Equity in earnings of Metro, Inc. (7,947) --
Proceeds from dividends from Metro, Inc. 1,702 --
Other changes in assets and liabilities:
Decrease in receivables 44,021 16,477
Decrease (increase) in inventories 3,866 (20,747)
Increase in prepaid expenses and other current assets (4,058) (2,779)
Increase in other assets (2,620) (434)
Increase in accounts payable 1,766 6,824
Decrease in accrued salaries, wages and benefits, and taxes (19,387) (19,054)
Decrease in other accruals (47,337) (7,277)
Decrease in minority interest -- (1,533)
Decrease in other non-current liabilities (14,220) (11,425)
Other operating activities, net 1,449 2,105
--------- --------
Net cash (used in) provided by operating activities (2,768) 1,231
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for property (68,129) (69,820)
Proceeds from disposal of property 10,384 31,573
Disposal related expenditures for sale of Canadian operations (326) --
Decrease in restricted cash 76,827 --
Purchases of marketable securities (148,700) --
Proceeds from maturities of marketable securities 219,404 --
--------- --------
Net cash provided by (used in) investing activities 89,460 (38,247)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term borrowings 288,300 --
Principal payments on long-term borrowings (217,826) (14,512)
Long-term real estate liabilities (920) 834
Principal payments on capital leases (1,974) (2,238)
Increase in book overdrafts 7,612 1,463
Deferred financing fees (75) (731)
Dividends paid (299,089) --
Proceeds from stock option exercise 4,602 11,774
--------- --------
Net cash used in financing activities (219,370) (3,410)
Effect of exchange rate changes on cash and cash equivalents 110 (3,098)
--------- --------
Net decrease in cash and cash equivalents (132,568) (43,524)
Cash and cash equivalents at beginning of period 229,589 257,748
--------- --------
Cash and cash equivalents at end of period $ 97,021 $214,224
========= ========
SUPPLEMENTAL DISCOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 6,868 $ 23,035
Income taxes $ 2,556 $ 2,082
See Notes to Quarterly Report
5
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying Consolidated Statements of Operations, Consolidated Statements
of Stockholders' Equity and Comprehensive Income (Loss), and Consolidated
Statements of Cash Flows for the 16 weeks ended June 17, 2006 and June 18, 2005,
and the Consolidated Balance Sheets at June 17, 2006 and February 25, 2006 of
The Great Atlantic & Pacific Tea Company, Inc. ("We," "Our," or "Our Company")
are unaudited and, in the opinion of management, contain all adjustments that
are of a normal and recurring nature necessary for a fair statement of financial
position and results of operations for such periods. The consolidated financial
statements should be read in conjunction with the consolidated financial
statements and related notes contained in our Fiscal 2005 Annual Report on Form
10-K. Interim results are not necessarily indicative of results for a full year.
The consolidated financial statements include the accounts of our Company and
all majority-owned subsidiaries. Significant intercompany accounts and
transactions have been eliminated. Our Company uses the equity method of
accounting for our investment in Metro, Inc. as we can exert significant
influence over substantive operating decisions made by Metro, Inc. through our
membership on Metro, Inc.'s Board of Directors and its committees and through an
information technology services agreement with Metro, Inc.
Certain reclassifications have been made to prior year amounts to conform to
current year presentation.
2. IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standard Board ("FASB") issued SFAS
151, "Inventory Costs, an Amendment of ARB No. 43, Chapter 4" ("SFAS 151"). SFAS
151 requires that handling costs and waste material (spoilage) be recognized as
current-period charges regardless of whether they meet the previous requirement
of being abnormal. In addition, this Statement requires that allocations of
fixed overhead to the cost of inventory be based on the normal capacity of the
production facilities. SFAS 151 is effective for our 2006 fiscal year. We have
evaluated the provisions of SFAS 151 and concluded that its adoption did not
have a material impact on our consolidated financial position or results of
operations.
In December 2004, the FASB issued SFAS 153, "Exchanges of Nonmonetary Assets, an
Amendment of APB Opinion No. 29" ("SFAS 153"). SFAS 153 is based on the
principle that exchanges of nonmonetary assets should be measured based on the
fair value of the assets exchanged. This pronouncement amends APB No. 29 to
eliminate the exception for nonmonetary exchanges of similar productive assets
and replaces it with a general exception for exchanges of nonmonetary assets
that do not have commercial substance. A nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. SFAS 153 is effective for nonmonetary
exchanges occurring in fiscal periods beginning after June 15, 2005 (the quarter
ended June 17, 2006 for our Company). We have evaluated the provisions of SFAS
153 and concluded that its adoption did not have a material impact on our
consolidated financial position or results of operations.
6
In May 2005, the FASB issued SFAS 154, "Accounting Changes and Error
Corrections" ("SFAS 154") which replaces Accounting Principles Board Opinions
No. 20 "Accounting Changes" and SFAS No. 3, "Reporting Accounting Changes in
Interim Financial Statements-An Amendment of APB Opinion No. 28." SFAS 154
provides guidance on the accounting for and reporting of accounting changes and
error corrections. It establishes retrospective application, unless
impracticable, as the required method for reporting a change in accounting
principle and the reporting of a correction of an error. FAS 154 is effective
for accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. We have evaluated the provisions of SFAS 154 and have
concluded that we have not had an accounting change or error correction that
would require retrospective application in the first quarter of fiscal 2006.
In September 2005, the FASB ratified the consensus reached in EITF Issue No.
04-13, "Accounting for Purchases and Sales of Inventory with the Same
Counterparty" (EITF 04-13). EITF 04-13 defines when a purchase and a sale of
inventory with the same party that operates in the same line of business should
be considered a single nonmonetary transaction. EITF 04-13 is effective for new
arrangements that a company enters into in periods beginning after March 15,
2006 (our second quarter beginning June 18, 2006). We have evaluated the
provisions of EITF 04-13 and have adopted the guidance. This adoption did not
have a material impact on our Company's financial position or results of
operations.
In October 2005, the FASB issued FASB Staff Position FAS 13-1 ("FSP FAS 13-1"),
which requires companies to expense rental costs associated with ground or
building operating leases that are incurred during a construction period. As a
result, companies that are currently capitalizing these rental costs are
required to expense them beginning in its first reporting period beginning after
December 15, 2005. FSP FAS 13-1 is effective for our Company as of the first
quarter of fiscal 2006. We evaluated the provisions of FSP FAS 13-1 and have
adopted the guidance. This adoption did not have a material impact on our
Company's financial position or results of operations.
On November 3, 2005, the FASB issued FASB Staff Position FAS 115-1 and FAS
124-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments" (FSP FAS 115-1 and FAS 124-1"). FSP FAS 115-1 and FAS 124-1
address the determination as to when an investment is considered impaired,
whether that impairment is other-than-temporary and the measurement of loss. It
also includes accounting considerations subsequent to the recognition of an
other-than-temporary impairment and requires certain disclosures about
unrealized losses that have not been recognized as other-than-temporary
impairments. FSP FAS 115-1 and FAS 124-1 are effective for reporting periods
beginning after December 15, 2005 and are required to be adopted by our Company
in the first quarter of fiscal 2006. We have adopted the guidance and included
the necessary disclosures relating to unrealized losses that have not been
recognized as other-than-temporary impairments in Note 5 - Cash, Restricted
Cash, Cash Equivalents and Marketable Securities at June 17, 2006.
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes--an Interpretation of FASB Statement 109 ("FIN 48"),
which clarifies the accounting for uncertainty in tax positions. This
Interpretation provides that the tax effects from an uncertain tax position can
be recognized in our financial statements, only if the position is more likely
than not of being sustained on audit, based on the technical merits of the
position. The provisions of FIN 48 are effective as of the beginning of fiscal
2007, with the cumulative effect of the change in accounting principle recorded
as an adjustment to opening retained earnings. We are currently evaluating the
impact of adopting FIN 48 on our financial statements.
7
3. SPECIAL ONE-TIME DIVIDEND
On April 25, 2006, our Company paid a special one-time dividend to our
shareholders of record on April 17, 2006 equal to $7.25 per share. This dividend
payout totaling $299.1 million was considered a return of capital to our
shareholders and accordingly was recorded as a reduction of "Additional paid in
capital" in our Consolidated Balance Sheets at June 17, 2006. The transaction
was funded primarily by cash available on the balance sheet resulting from the
strategic restructuring of the Company during fiscal 2005.
Although we paid this one-time special dividend, our Company's practice is to
not pay dividends. As such, we have not made dividend payments in the previous
three years and do not intend to pay dividends in the normal course of business
in fiscal 2006. However, our Company is permitted, under the terms of our
Revolver, to pay cash dividends on common shares.
In connection with the payment of the special one-time dividend discussed above,
our Company also adjusted the number and/or price of all unexercised stock
compensation as of April 12, 2006, to ensure that an individual's right to
purchase stock at an aggregate value remained the same both before and after the
special one-time dividend payment. These adjustments did not have an impact on
stock compensation expense for the 16 weeks ended June 17, 2006. Refer to Note
10 - Stock Based Compensation for adjustments made to stock options outstanding
and nonvested performance restricted stock units as a result of the dividend.
4. EQUITY INVESTMENT IN METRO, INC.
We use the equity method of accounting to account for our investment in Metro,
Inc. on the basis that we have significant influence over substantive operating
decisions made by Metro, Inc. through our membership on Metro, Inc.'s Board of
Directors and its committees and through an information technology services
agreement with Metro, Inc. The value of our equity investment in Metro, Inc.
based upon Metro, Inc.'s quoted market price is $502.6 million at June 17, 2006.
The following table summarizes the status and results of our Company's equity
investment in Metro, Inc. from February 25, 2006 through June 17, 2006:
Equity investment at February 25, 2006 $338,756
Dividends and distributions received (1,702)
Equity earnings in Metro, Inc. 7,947
Foreign currency translation 11,485
--------
Equity investment at June 17, 2006 $356,486
========
In accordance with Emerging Issues Task Force ("EITF") 01-2, "Interpretations of
APB Opinion No. 29," we have indefinitely deferred $171.7 million of the gain
resulting from the sale of our Canadian operations that directly related to the
economic interest we retained in Metro, Inc. We will record our equity earnings
or losses relating to our equity investment in Metro, Inc. on about a
three-month lag period as permitted by APB 18, "The Equity Method of Accounting
for Investments in Common Stock." Thus, during the first quarter ended June 17,
2006, we recorded $7.9 million in equity earnings relating to our equity
investment in Metro, Inc. and included this amount in "Equity in earnings of
Metro, Inc." on our Consolidated Statements of Operations.
8
The difference between the carrying value of our investment of $356.5 million
and the amount of our underlying equity in Metro, Inc.'s net assets of $223.8
million is $132.7 million.
5. CASH, RESTRICTED CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES
At June 17, 2006 and February 25, 2006, we had $69.5 million and $146.3 million,
respectively, in restricted cash, which was held in a money market fund, and can
only be used as collateral for our new Letter of Credit Agreement that we
entered into during fiscal 2005. In addition, our marketable securities of $95.9
million at June 17, 2006, held by Bank of America, can also only be used as
collateral for our new Letter of Credit Agreement that we entered into during
fiscal 2005.
The following is a summary of cash, cash equivalents, restricted cash, and
marketable securities at June 17, 2006 and February 25, 2006:
At June 17, 2006
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Costs Gains Losses Value
--------- ---------- ---------- ---------
CLASSIFIED AS:
Cash $ 89,528 $-- $ -- $ 89,528
Cash equivalents:
Money market funds 7,493 -- -- 7,493
-------- --- ------- --------
Total cash and cash equivalents 97,021 -- -- 97,021
-------- --- ------- --------
Restricted cash 69,482 -- -- 69,482
Restricted marketable securities:
Corporate bonds 51,486 -- (386) 51,100
Securities of the U.S. government
and its agencies 45,551 -- (743) 44,808
-------- --- ------- --------
Total restricted marketable securities 97,037 -- (1,129) 95,908
-------- --- ------- --------
Total cash, cash equivalents, restricted cash and
marketable securities $263,540 $-- $(1,129) $262,411
======== === ======= ========
SECURITIES AVAILABLE-FOR-SALE:
Maturing within one year $ 58,979 $ 58,593
======== ========
Maturing greater than one year $ 45,551 $ 44,808
======== ========
9
At February 25, 2006
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Costs Gains Losses Value
--------- ---------- ---------- ---------
CLASSIFIED AS:
Cash $ 78,414 $-- $ -- $ 78,414
Cash equivalents:
Money market funds 151,175 -- -- 151,175
-------- --- ------- --------
Total cash and cash equivalents 229,589 -- -- 229,589
-------- --- ------- --------
Restricted cash 146,309 -- -- 146,309
Marketable securities:
Corporate bonds 51,456 -- (457) 50,999
Securities of the U.S. government
and its agencies 45,943 -- (558) 45,385
Auction rate securities 71,021 -- -- 71,021
-------- --- ------- --------
Total marketable securities 168,420 -- (1,015) 167,405
-------- --- ------- --------
Total cash, cash equivalents, restricted cash and
marketable securities $544,318 $-- $(1,015) $543,303
======== === ======= ========
SECURITIES AVAILABLE-FOR-SALE:
Maturing within one year $233,921 $233,879
======== ========
Maturing greater than one year $ 85,674 $ 84,701
======== ========
The following table provides the breakdown of the investments with unrealized
losses at June 17, 2006 and February 25, 2006:
June 17, 2006
------------------------------------------------------------------
Less than 12 Months 12 Months or Longer Total
-------------------- -------------------- --------------------
Gross Gross Gross
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------- ---------- ------- ---------- ------- ----------
Corporate bonds $51,100 $(386) $ -- $ -- $51,100 $ (386)
Securities of the U.S.
government and
its agencies -- -- 44,808 (743) 44,808 (743)
------- ----- ------- ----- ------- -------
Total $51,100 $(386) $44,808 $(743) $95,908 $(1,129)
======= ===== ======= ===== ======= =======
February 25, 2006
------------------------------------------------------------------
Less than 12 Months 12 Months or Longer Total
-------------------- -------------------- --------------------
Gross Gross Gross
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------- ---------- ------- ---------- ------- ----------
Corporate bonds $11,683 $(41) $39,316 $(416) $50,999 $ (457)
Securities of the U.S.
government and
its agencies -- -- 45,385 (558) 45,385 (558)
------- ---- ------- ----- ------- -------
Total $11,683 $(41) $84,701 $(974) $96,384 $(1,015)
======= ==== ======= ===== ======= =======
10
Corporate bonds: Our unrealized losses on our investments in corporate bonds
were caused by interest rate increases by the Federal Reserve. The contractual
terms of those investments do not permit the issuer to settle the security at a
price less than the amortized cost of the investment. We believe it is probable
that we will be able to collect all amounts due according to the contractual
terms of these investments. Therefore, it is expected that the debentures would
not be settled at a price less than the amortized cost of the investment.
Because we have the ability and intent to hold those investments until a
recovery of fair value, which may be maturity, we do not consider those
investments to be other-than-temporarily impaired at June 17, 2006 and February
25, 2006, respectively.
Securities of the U.S. government and its agencies: Our unrealized losses on our
investments in securities of the U.S. government and its agencies were caused by
interest rate increases by the Federal Reserve. The contractual terms of those
investments do not permit the issuer to settle the securities at a price less
than the amortized cost of the investment. Because we have the ability and
intent to hold those investments until a recovery of fair value, which may be
maturity, we do not consider those investments to be other-than-temporarily
impaired at June 17, 2006 and February 25, 2006, respectively.
Gross realized gains or losses on sales of investments were $0.05 million and
nil for the 16 weeks ended June 17, 2006 and June 18, 2005, respectively.
6. VALUATION OF LONG-LIVED ASSETS
In accordance with SFAS 144, we review the carrying values of our long-lived
assets for possible impairment whenever events or changes in circumstances
indicate that the carrying amount of assets may not be recoverable. Such review
is primarily based upon groups of assets and the undiscounted estimated future
cash flows from such assets to determine if the carrying value of such assets is
recoverable from their respective cash flows. If such review indicates an
impairment exists, we measure such impairment on a discounted basis using a
probability-weighted approach and a 7 year U.S. Treasury risk-free rate.
During the 16 weeks ended June 17, 2006 and June 18, 2005, we recorded
impairment losses on long-lived assets of $2.3 million and $6.4 million,
respectively, as follows:
Impairments due to closure or conversion in the normal course of business
We review assets in stores planned for closure or conversion for impairment upon
determination that such assets will not be used for their intended useful life.
During the 16 weeks ended June 17, 2006 and June 18, 2005, we recorded
impairment losses on property, plant and equipment of $1.2 million and $0.5
million, respectively, related to stores that were or will be closed or
converted in the normal course of business. This amount was included in "Store
operating, general and administrative expense" in our Consolidated Statements of
Operations.
Impairments related to our Asset Disposition Initiatives
During the 16 weeks ended June 17, 2006 and June 18, 2005, we recorded
impairment losses on property, plant and equipment of $1.1 million and $5.9
million, respectively, related to property write-downs as a result of our asset
disposition initiatives as discussed in Note 8 - Asset Disposition Initiatives.
These amounts were included in "Store operating, general and administrative
expense" in our Consolidated Statements of Operations for the 16 weeks ended
June 17, 2006 and June 18, 2005.
11
The effects of changes in estimates of useful lives were not material to ongoing
depreciation expense.
7. DISCONTINUED OPERATIONS
In February 2003, we announced the sale of a portion of our non-core assets,
including nine of our stores in northern New England and seven stores in
Madison, Wisconsin. In March 2003, we entered into an agreement to sell an
additional eight stores in northern New England.
During fiscal 2003, we adopted a formal plan to exit the New England and
Wisconsin markets as well as our Eight O'Clock Coffee business through the sale
and/or disposal of these assets.
Summarized below are the operating results for these discontinued businesses,
which are included in our Consolidated Statements of Operations, under the
caption "Loss from operations of discontinued businesses, net of tax" for the 16
weeks ended June 17, 2006 and June 18, 2005.
16 Weeks Ended June 17, 2006
--------------------------------------
Eight
Northern O'Clock
New England Kohl's Coffee Total
----------- ------ ------- -----
LOSS FROM OPERATIONS OF
DISCONTINUED BUSINESSES
Sales $ -- $ -- $-- $ --
Operating expenses (14) (669) -- (683)
---- ----- --- -----
Loss from operations of
discontinued businesses, before
tax (14) (669) -- (683)
Tax benefit -- -- -- --
---- ----- --- -----
Loss from operations of
discontinued businesses, net
of tax $(14) $(669) $-- $(683)
==== ===== === =====
Disposal related costs included in operating expenses above:
Non-accruable closing costs $(14) $ 4 $-- $ (10)
Vacancy costs -- (541) -- (541)
Interest accretion on present value
of future occupancy costs -- (132) -- (132)
---- ----- --- -----
Total disposal related costs $(14) $(669) $-- $(683)
==== ===== === =====
12
16 Weeks Ended June 18, 2005
--------------------------------------
Eight
Northern O'Clock
New England Kohl's Coffee Total
----------- ------ ------- -----
LOSS FROM OPERATIONS OF
DISCONTINUED BUSINESSES
Sales $ -- $ -- $ -- $ --
Operating expenses (27) (131) (10) (168)
---- ----- ----- -----
Loss from operations of
discontinued businesses, before
tax (27) (131) (10) (168)
Tax benefit 11 56 4 71
---- ----- ----- -----
Loss from operations of
discontinued businesses, net
of tax $(16) $ (75) $ (6) $ (97)
==== ===== ===== =====
Disposal related costs included in operating expenses above:
Non-accruable closing costs $(27) $ 75 $ (10) $ 38
Interest accretion on present value
of future occupancy costs -- (206) -- (206)
---- ----- ----- -----
Total disposal related costs $(27) $(131) $ (10) $(168)
---- ----- ----- -----
NORTHERN NEW ENGLAND
During the first quarters of fiscal 2006 and fiscal 2005, we incurred additional
costs to wind down our operations in this region subsequent to the sale of these
stores of $0.01 million and $0.03 million, respectively, primarily related to
non-accruable closing costs, which were included in "Loss from operations of
discontinued businesses, net of tax" on our Consolidated Statements of
Operations.
KOHL'S MARKET
During the first quarter of fiscal 2006, we recorded costs of $0.7 million
primarily relating to additional vacancy costs that were recorded due to changes
in our estimation of such future costs as well as additional costs to wind down
this business. During the first quarter of fiscal 2005, we recorded costs of
$0.1 million primarily relating to the costs of winding down this business.
These amounts were recorded in "Loss from operations of discontinued businesses,
net of tax" on our Consolidated Statements of Operations for the 16 weeks ended
June 17, 2006 and June 18, 2005.
13
The following table summarizes the reserve activity related to the exit of the
Kohl's market since the charge was recorded through the 16 weeks ended June 17,
2006:
Severance
and Fixed
Occupancy Benefits Assets Total
--------- --------- ------- -------
Fiscal 2003 charge (1) $25,487 $13,062 $18,968 $57,517
Additions (2) 352 -- -- 352
Utilization (3) (5,342) (8,228) (18,968) (32,538)
Adjustments (4) (1,458) -- -- (1,458)
------- ------- ------- -------
Balance at February 28, 2004 $19,039 $ 4,834 $ -- $23,873
Additions (2) 688 52 602 1,342
Utilization (3) (1,918) (2,201) (602) (4,721)
Adjustments (4) (354) -- -- (354)
------- ------- ------- -------
Balance at February 26, 2005 $17,455 $ 2,685 $ -- $20,140
Additions (2) 562 44 -- 606
Utilization (3) (3,235) (2,128) -- (5,363)
Adjustments (4) (4,299) 582 -- (3,717)
------- ------- ------- -------
Balance at February 25, 2006 $10,483 $ 1,183 $ -- $11,666
Additions (2) 128 4 -- 132
Utilization (3) (868) (1,187) -- (2,055)
Adjustments (4) 541 -- -- 541
------- ------- ------- -------
Balance at June 17, 2006 $10,284 $ -- $ -- $10,284
======= ======= ======= =======
(1) The fiscal 2003 charge to occupancy consists of $25.5 million related to
future occupancy costs such as rent, common area maintenance and real
estate taxes. The fiscal 2003 charge to severance and benefits of $13.1
million related to severance costs of $6.6 million and costs for future
obligations for early withdrawal from multi-employer union pension plans
and a health and welfare plan of $6.5 million. The fiscal 2003 charge to
property of $18.9 million represents the impairment losses at certain
Kohl's locations.
(2) The fiscal 2003, fiscal 2004, fiscal 2005 and the first quarter of fiscal
2006 additions to occupancy and severance and benefits represent the
interest accretion on future occupancy costs and future obligations for
early withdrawal from multi-employer union pension plans which were
recorded at present value at the time of the original charge. The addition
to fixed assets represents additional impairment losses recorded as a
result of originally estimated proceeds on the disposal of these assets not
being achieved.
(3) Occupancy utilization represents vacancy related payments for closed
locations such as rent, common area maintenance, real estate taxes and
lease termination payments. Severance and benefits utilization represents
payments made to terminated employees during the period and payments for
pension withdrawal.
(4) At each balance sheet date, we assess the adequacy of the balance to
determine if any adjustments are required as a result of changes in
circumstances and/or estimates. During fiscal 2003, we recorded net
adjustments of $1.5 million primarily related to reversals of previously
accrued vacancy costs due to favorable results of terminating and
subleasing certain locations of $4.5 million offset by additional vacancy
accruals of $3.0 million. During fiscal 2004, we recorded a reversal of
previously accrued occupancy related costs due to favorable results of
terminating leases. During fiscal 2005, we recorded adjustments relating to
(i.) a reversal of previously accrued occupancy costs of $3.7 million due
to favorable results of terminating the Kohl's warehouse lease and (ii.)
the reclassification of $0.6 million between the liabilities for occupancy
and severance and benefits to properly state their respective ending
balances at February 25, 2006. During the first quarter of fiscal 2006, we
recorded adjustments for additional vacancy related costs for our
properties of $0.5 million due to changes in our estimation of such future
costs.
We paid $11.4 million of the total occupancy charges from the time of the
original charge through June 17, 2006 which was primarily for occupancy related
costs such as rent, common area maintenance, real estate taxes and lease
termination costs. The remaining occupancy liability of $10.3 million relates to
expected future payments under long term leases and is expected to be paid out
in full by 2020.
14
We paid $13.7 million of the total original severance and benefits charges from
the time of the original charges through June 17, 2006, which resulted from the
termination of approximately 2,000 employees. At June 17, 2006, there are no
future obligations for severance and benefits.
At June 17, 2006 and February 25, 2006, $2.7 million and $3.7 million,
respectively, of the Kohl's exit reserves was included in "Other accruals" and
$7.6 million and $8.0 million, respectively, was included in "Other non-current
liabilities" on our Consolidated Balance Sheets. We have evaluated the liability
balance of $10.3 million as of June 17, 2006 based upon current available
information and have concluded that it is adequate. We will continue to monitor
the status of the vacant properties and adjustments to the reserve balance may
be recorded in the future, if necessary.
EIGHT O'CLOCK COFFEE
During fiscal 2003, we completed the sale of our Eight O'Clock Coffee business,
generating gross proceeds of $107.5 million and a net gain after transaction
related costs of $85.0 million ($49.3 million after tax). The sale of the coffee
business also included a contingent note for up to $20.0 million, the value and
payment of which is based upon certain elements of the future performance of the
Eight O'Clock Coffee business and therefore is not included in the gain.
During the 16 weeks ended June 17, 2006 and June 18, 2005, we incurred
additional costs to wind down our operations in this business subsequent to the
sale of nil and $0.01 million, respectively. These amounts were included in
"Loss from operations of discontinued businesses, net of tax" on our
Consolidated Statements of Operations.
15
8. ASSET DISPOSITION INITIATIVES
Presented below is a reconciliation of the charges recorded on our Consolidated
Balance Sheets, Consolidated Statements of Operations and Consolidated
Statements of Cash Flows for the 16 weeks ended June 17, 2006 and June 18, 2005.
Present value ("PV") interest represents interest accretion on future occupancy
costs which were recorded at present value at the time of the original charge.
Non-accruable items represent charges related to the restructuring that are
required to be expensed as incurred in accordance with SFAS 146 "Accounting for
Costs Associated with Exit or Disposal Activities".
16 weeks ended June 17, 2006
------------------------------------------------------------------------------
U.S.
Project 2001 Farmer Closure of Distribution
Great Asset Jack Stores in Operations and
Renewal Disposition Restructuring the Midwest Warehouses Total
------- ----------- ------------- ----------- -------------- -------
BALANCE SHEET ACCRUALS
Vacancy $(1,165) $4,433 $(3,021) $ 5,040 $ 873 $ 6,160
PV interest 344 526 234 1,141 79 2,324
Severance -- -- -- (20) 541 521
Total accrued to
balance sheets
------- ------ ------- ------- ------- -------
(821) 4,959 (2,787) 6,161 1,493 9,005
------- ------ ------- ------- ------- -------
NON-ACCRUABLE ITEMS
RECORDED ON STATEMENTS
OF OPERATIONS
Property writeoffs -- -- -- -- 1,049 1,049
Inventory related costs -- -- -- -- (571) (571)
Loss on sale of property -- -- -- 92 -- 92
Closing costs -- -- -- 69 1,919 1,988
------- ------ ------- ------- ------- -------
Total non-accruable items -- -- -- 161 2,397 2,558
------- ------ ------- ------- ------- -------
Less PV interest (344) (526) (234) (1,141) (79) (2,324)
------- ------ ------- ------- ------- -------
TOTAL AMOUNT RECORDED
ON STATEMENTS OF
OPERATIONS EXCLUDING
PV INTEREST (1,165) 4,433 (3,021) 5,181 3,811 9,239
------- ------ ------- ------- ------- -------
Less closing costs -- -- -- (69) (1,919) (1,988)
------- ------ ------- ------- ------- -------
TOTAL AMOUNT RECORDED
ON STATEMENTS OF
CASH FLOWS $(1,165) $4,433 $(3,021) $ 5,112 $ 1,892 $ 7,251
======= ====== ======= ======= ======= =======
16
16 weeks ended June 18, 2005
------------------------------------------------------------------------------
U.S.
Project 2001 Farmer Closure of Distribution
Great Asset Jack Stores in Operations and
Renewal Disposition Restructuring the Midwest Warehouses Total
------- ----------- ------------- ----------- -------------- -------
BALANCE SHEET ACCRUALS
Vacancy $ -- $ -- $ -- $14,766 $ -- $14,766
PV interest 525 713 194 -- -- 1,432
Severance -- -- -- 1,337 40,417 41,754
----- ----- ----- ------- ------- -------
Total accrued to
balance sheets 525 713 194 16,103 40,417 57,952
----- ----- ----- ------- ------- -------
NON-ACCRUABLE ITEMS
RECORDED ON STATEMENTS
OF OPERATIONS
Property writeoffs -- -- -- 126 5,811 5,937
Inventory related costs -- -- -- 586 1,030 1,616
Gain on sale of property -- -- -- (952) -- (952)
Gain on sale of pharmacy
scripts -- -- -- (870) -- (870)
Closing costs -- -- -- 432 701 1,133
----- ----- ----- ------- ------- -------
Total non-accruable items -- -- -- (678) 7,542 6,864
----- ----- ----- ------- ------- -------
Less PV interest (525) (713) (194) -- -- (1,432)
----- ----- ----- ------- ------- -------
TOTAL AMOUNT RECORDED
ON STATEMENTS OF
OPERATIONS EXCLUDING
PV INTEREST -- -- -- 15,425 47,959 63,384
----- ----- ----- ------- ------- -------
Less Gain on sale
of pharmacy
scripts -- -- -- 870 -- 870
Less closing costs -- -- -- (432) (701) (1,133)
----- ----- ----- ------- ------- -------
TOTAL AMOUNT RECORDED
ON STATEMENTS OF
CASH FLOWS $ -- $ -- $ -- $15,863 $47,258 $63,121
===== ===== ===== ======= ======= =======
17
PROJECT GREAT RENEWAL
The following table summarizes the activity related to this phase of the
initiative over the last three fiscal years:
Occupancy Severance and Benefits Total
---------------------------- -------------------------- ----------------------------
U.S. Canada Total U.S. Canada Total U.S. Canada Total
-------- ------ -------- ------- ------ ------- -------- ------ --------
Balance at
February 22, 2003 $ 48,788 $ 487 $ 49,275 $ 2,446 $-- $ 2,446 $ 51,234 $ 487 $ 51,721
Addition (1) 2,276 372 2,648 -- -- -- 2,276 372 2,648
Utilization (2) (19,592) (407) (19,999) (289) -- (289) (19,881) (407) (20,288)
-------- ----- -------- ------- --- ------- -------- ----- --------
Balance at
February 28, 2004 $ 31,472 $ 452 $ 31,924 $ 2,157 $-- $ 2,157 $ 33,629 $ 452 $ 34,081
Addition (1) 1,902 20 1,922 -- -- -- 1,902 20 1,922
Utilization (2) (5,410) (222) (5,632) (497) -- (497) (5,907) (222) (6,129)
-------- ----- -------- ------- --- ------- -------- ----- --------
Balance at
February 26, 2005 $ 27,964 $ 250 $ 28,214 $ 1,660 $-- $ 1,660 $ 29,624 $ 250 $ 29,874
Addition (1) 1,541 7 1,548 -- -- -- 1,541 7 1,548
Utilization (2) (5,858) (167) (6,025) (223) -- (223) (6,081) (167) (6,248)
Adjustments (3) (3,648) (90) (3,738) -- -- -- (3,648) (90) (3,738)
-------- ----- -------- ------- --- ------- -------- ----- --------
Balance at
February 25, 2006 $ 19,999 $ -- $ 19,999 $ 1,437 $-- $ 1,437 $ 21,436 $ -- $ 21,436
Addition (1) 344 -- 344 -- -- -- 344 -- 344
Utilization (2) (1,565) -- (1,565) (33) -- (33) (1,598) -- (1,598)
Adjustments (3) (1,165) -- (1,165) -- -- -- (1,165) -- (1,165)
-------- ----- -------- ------- --- ------- -------- ----- --------
Balance at
June 17, 2006 $ 17,613 $ -- $ 17,613 $ 1,404 $-- $ 1,404 $ 19,017 $ -- $ 19,017
======== ===== ======== ======= === ======= ======== ===== ========
(1) The additions to store occupancy of $2.6 million, $1.9 million, and $1.5
million during fiscal 2003, 2004 and 2005, respectively, and $0.3 million
during the 16 weeks ended June 17, 2006 represent the interest accretion on
future occupancy costs which were recorded at present value at the time of
the original charge.
(2) Occupancy utilization of $20.0 million, $5.6 million, and $6.0 million for
fiscal 2003, 2004 and 2005, respectively, and $1.6 million during the 16
weeks ended June 17, 2006 represents payments made during those periods for
costs such as rent, common area maintenance, real estate taxes and lease
termination costs. Severance utilization of $0.3 million, $0.5 million, and
$0.2 million for fiscal 2003, 2004 and 2005, respectively, and $0.03
million during the 16 weeks ended June 17, 2006 represents payments to
individuals for severance and benefits, as well as payments to pension
funds for early withdrawal from multi-employer union pension plans.
(3) At each balance sheet date, we assess the adequacy of the balance to
determine if any adjustments are required as a result of changes in
circumstances and/or estimates. We have continued to make favorable
progress in marketing and subleasing the closed stores. As a result, during
fiscal 2005, we recorded an additional reduction of $3.6 million in
occupancy accruals due to subleasing additional closed stores and
converting a previously closed store to a store that will open in fiscal
2006. During the first quarter of fiscal 2006, we recorded adjustments for
a reduction in vacancy related costs for our properties of $1.2 million due
to changes in our estimation of such future costs.
We paid $105.9 million of the total occupancy charges from the time of the
original charges through June 17, 2006 which was primarily for occupancy related
costs such as rent, common area maintenance, real estate taxes and lease
termination costs. We paid $30.2 million of the total net severance charges from
the time of the original charges through June 17, 2006, which resulted from the
termination of approximately 3,400 employees. The remaining occupancy liability
of $17.6 million relates to expected future payments under long term leases and
is expected to be paid in full by 2020. The remaining severance liability of
$1.4 million primarily relates to expected future payments for early withdrawals
from multi-employer union pension plans and will be fully paid out in 2020. None
of these stores were open during either of the first quarters of fiscal 2005 or
fiscal 2006.
18
At June 17, 2006 and February 25, 2006, approximately $4.5 million and $5.1
million, respectively, of the reserve was included in "Other accruals" and the
remaining amount was included in "Other non-current liabilities" on the
Company's Consolidated Balance Sheets.
Based upon current available information, we evaluated the reserve balances as
of June 17, 2006 of $19.0 million for this phase of the asset disposition
initiative and have concluded that they are adequate to cover expected future
costs. The Company will continue to monitor the status of the vacant properties
and adjustments to the reserve balances may be recorded in the future, if
necessary.
2001 ASSET DISPOSITION
The following table summarizes the activity related to this phase of the
initiative recorded on the Consolidated Balance Sheets over the last three
fiscal years:
Occupancy Severance and Benefits Total
--------------------------- --------------------------- -----------------------------
U.S. Canada Total U.S. Canada Total U.S. Canada Total
------- ------ -------- ------- ------- ------- -------- ------- --------
Balance at
February 22, 2003 $53,502 $ 344 $ 53,846 $ 3,813 $ 481 $ 4,294 $ 57,315 $ 825 $ 58,140
Addition (1) 2,847 3 2,850 -- -- -- 2,847 3 2,850
Utilization (2) (9,987) (974) (10,961) (2,457) (1,026) (3,483) (12,444) (2,000) (14,444)
Adjustments (3) (6,778) 1,002 (5,776) 955 603 1,558 (5,823) 1,605 (4,218)
------- ------ -------- ------- ------- ------- -------- ------- --------
Balance at
February 28, 2004 $39,584 $ 375 $ 39,959 $ 2,311 $ 58 $ 2,369 $ 41,895 $ 433 $ 42,328
Addition (1) 2,449 -- 2,449 -- -- -- 2,449 -- 2,449
Utilization (2) (5,646) (375) (6,021) (2,197) (58) (2,255) (7,843) (433) (8,276)
Adjustments (3) (4,488) -- (4,488) -- -- -- (4,488) -- (4,488)
------- ------ -------- ------- ------- ------- -------- ------- --------
Balance at
February 26, 2005 $31,899 $ -- $ 31,899 $ 114 $ -- $ 114 $ 32,013 $ -- $ 32,013
Addition (1) 2,170 -- 2,170 -- -- -- 2,170 -- 2,170
Utilization (2) (5,262) -- (5,262) (97) -- (97) (5,359) -- (5,359)
Adjustments (3) (2,089) -- (2,089) -- -- -- (2,089) -- (2,089)
------- ------ -------- ------- ------- ------- -------- ------- --------
Balance at
February 25, 2006 $26,718 $ -- $ 26,718 $ 17 $ -- $ 17 $ 26,735 $ -- $ 26,735
Addition (1) 526 -- 526 -- -- -- 526 -- 526
Utilization (2) (6,277) -- (6,277) (4) -- (4) (6,281) -- (6,281)
Adjustments (3) 4,433 -- 4,433 -- -- -- 4,433 -- 4,433
------- ------ -------- ------- ------- ------- -------- ------- --------
Balance at
June 17, 2006 $25,400 $ -- $ 25,400 $ 13 $ -- $ 13 $ 25,413 $ -- $ 25,413
======= ====== ======== ======= ======= ======= ======== ======= ========
(1) The additions to store occupancy of $2.9 million, $2.4 million, and $2.2
million during fiscal 2003, 2004 and 2005, respectively, and $0.5 million
during the 16 weeks ended June 17, 2006 represent the interest accretion on
future occupancy costs which were recorded at present value at the time of
the original charge.
(2) Occupancy utilization of $11.0 million, $6.0 million, and $5.3 during
fiscal 2003, 2004 and 2005, respectively, and $6.3 million during the 16
weeks ended June 17, 2006 represent payments made during those periods for
costs such as rent, common area maintenance, real estate taxes and lease
termination costs. Severance utilization of $3.5 million, $2.3 million, and
$0.1 million during fiscal 2003, 2004 and 2005, respectively, and $0.004
during the 16 weeks ended June 17, 2006 represent payments made to
terminated employees during the period.
(3) At each balance sheet date, we assess the adequacy of the reserve balance
to determine if any adjustments are required as a result of changes in
circumstances and/or estimates. During fiscal 2003, we recorded net
adjustments of $5.8 million related to reversals of previously accrued
occupancy costs due to favorable results of subleasing, assigning and
terminating leases. We also accrued $1.6 million for additional severance
and benefit costs that were unforeseen at the time of the original charge.
During fiscal 2004, we recorded adjustments of $4.5 million related to the
reversals of
19
previously accrued occupancy costs due to the disposals and subleases of
locations at more favorable terms than originally anticipated at the time
of the original charge. Finally, during fiscal 2005, we recorded
adjustments of $2.1 million related to the reversals of previously accrued
occupancy costs due to the favorable result of subleasing one of the closed
properties and changes in our original estimate of our future vacancy
obligations for closed stores. During the first quarter of fiscal 2006, we
recorded adjustments for additional vacancy related costs of $4.4 million
due to changes in our estimation of such future costs.
We paid $50.7 million ($47.7 million in the U.S. and $3.0 million in Canada) of
the total occupancy charges from the time of the original charges through June
17, 2006 which was primarily for occupancy related costs such as rent, common
area maintenance, real estate taxes and lease termination costs. We paid $28.2
million ($19.2 million in the U.S. and $9.0 million in Canada) of the total net
severance charges from the time of the original charges through June 17, 2006,
which resulted from the termination of approximately 1,100 employees. The
remaining occupancy liability of $25.4 million primarily relates to expected
future payments under long term leases through 2017. The remaining severance
liability of $0.01 million relates to expected future payments for severance and
benefits payments to individual employees and will be fully paid out in 2006.
None of these stores were open during either of the first quarters of fiscal
2006 or 2005.
At June 17, 2006 and February 25, 2006, approximately $5.9 million and $6.6
million of the reserve, respectively, was included in "Other accruals" and the
remaining amount was included in "Other non-current liabilities" on the
Company's Consolidated Balance Sheets.
Based upon current available information, we evaluated the reserve balances as
of June 17, 2006 of $25.4 million for this phase of the asset disposition
initiative and have concluded that they are adequate to cover expected future
costs. The Company will continue to monitor the status of the vacant properties
and adjustments to the reserve balances may be recorded in the future, if
necessary.
20
FARMER JACK RESTRUCTURING
The following table summarizes the activity to date related to the charges
recorded for this initiative all of which were in the U.S.
Severance
and
Occupancy Benefits Total
--------- --------- -------
Original charge (1) $20,999 $ 8,930 $29,929
Addition (1) 56 -- 56
Utilization (2) (1,093) (4,111) (5,204)
------- ------- -------
Balance at
February 28, 2004 $19,962 $ 4,819 $24,781
Addition (1) 687 -- 687
Utilization (2) (4,747) (4,813) (9,560)
------- ------- -------
Balance at
February 26, 2005 $15,902 $ 6 $15,908
Addition (1) 710 -- 710
Utilization (2) (2,738) (6) (2,744)
Adjustment (3) 4,376 -- 4,376
------- ------- -------
Balance at
February 25, 2006 $18,250 $ -- $18,250
Addition (1) 234 -- 234
Utilization (2) (520) -- (520)
Adjustment (3) (3,021) -- (3,021)
------- ------- -------
Balance at
June 17, 2006 $14,943 $ -- $14,943
======= ======= =======
(1) The original charge to occupancy during fiscal 2003 represents charges
related to closures and conversions in the Detroit, Michigan market of
$21.0 million. The additions to occupancy during fiscal 2003, fiscal 2004,
fiscal 2005 and the 16 weeks ended June 17, 2006 represent interest
accretion on future occupancy costs which were recorded at present value at
the time of the original charge. The original charge to severance during
fiscal 2003 of $8.9 million related to individual severings as a result of
the store closures, as well as a voluntary termination plan initiated in
the Detroit, Michigan market.
(2) Occupancy utilization of $1.1 million, $4.7 million, $2.7 million and $0.5
million during fiscal 2003, fiscal 2004, fiscal 2005 and for the 16 weeks
ended June 17, 2006, respectively, represents payments made for costs such
as rent, common area maintenance, real estate taxes and lease termination
costs. Severance utilization of $4.1 million, $4.8 million, $0.01 and nil
during fiscal 2003, fiscal 2004, fiscal 2005 and the 16 weeks ended June
17, 2006, respectively, represent payments made to terminated employees
during the period.
(3) At each balance sheet date, we assess the adequacy of the balance to
determine if any adjustments are required as a result of changes in
circumstances and/or estimates. During fiscal 2005, we recorded an increase
of $4.4 million in occupancy accruals due to changes in our original
estimate of when we would terminate certain leases, obtain sublease rental
income related to such leases and changes in our original estimate of our
future vacancy obligations for closed stores. During the first quarter of
fiscal 2006, we recorded adjustments for a reduction in vacancy related
costs for our properties of $3.0 million due to changes in our estimation
of such future costs.
We paid $9.1 million of the total occupancy charges from the time of the
original charge through June 17, 2006 which was primarily for occupancy related
costs such as rent, common area maintenance, real estate taxes and lease
termination costs. The remaining occupancy liability of $14.9 million relates to
expected future payments under long term leases and is expected to be paid out
in full by 2022. We paid $8.9 million of the total net severance charges from
the time of the original charges through June 17, 2006, which resulted from the
termination of approximately 300 employees. The severance liability has been
21
fully utilized and no additional future payments for severance and benefits to
individual employees will be paid out. None of these stores were open during
either of the first quarters of fiscal 2006 or 2005.
At June 17, 2006 and February 25, 2006, approximately $1.3 million and $1.6
million, respectively, of the liability was included in "Other accruals" and the
remaining amount was included in "Other non-current liabilities" on our
Consolidated Balance Sheets.
We have evaluated the liability balance of $14.9 million as of June 17, 2006
based upon current available information and have concluded that it is adequate.
We will continue to monitor the status of the vacant properties and adjustments
to the reserve balance may be recorded in the future, if necessary.
CLOSURE OF STORES IN THE MIDWEST
During the first quarter of fiscal 2005, we announced plans for a major
strategic restructuring that would focus future effort and investment on our
core operations in the Northeastern United States. Thus, we have initiated
efforts to close stores in the Midwest. This planned store closure included the
closing of a total of 35 stores, all of which have been closed as of June 17,
2006. The remaining business located in the Midwestern United States will
continue to operate as part of our core business going forward.
The following table summarizes the activity to date related to the charges
recorded for these store closures.
Severance
and
Occupancy Benefits Total
--------- --------- --------
Original charge (1) $14,766 $ 1,337 $ 16,103
Additions (2) 75,259 1,373 76,632
Utilization (3) (9,538) (2,439) (11,977)
Adjustment (4) 9,153 (44) 9,109
------- ------- --------
Balance at
February 25, 2006 $89,640 $ 227 $ 89,867
Additions (2) 1,141 -- 1,141
Utilization (3) (5,416) (183) (5,599)
Adjustment (4) 5,040 (20) 5,020
------- ------- --------
Balance at
June 17, 2006 $90,405 $ 24 $ 90,429
======= ======= ========
(1) The original charge to occupancy during fiscal 2005 represents charges
related to closures of the first 8 stores in conjunction with our decision
to close stores in the Midwest of $14.8 million. The original charge to
severance during fiscal 2005 of $1.3 million related to individual
severings as a result of these store closures.
(2) The additions to occupancy during fiscal 2005 represent charges related to
the closures of an additional 27 stores in the amount of $73.7 million and
interest accretion on future occupancy costs which were recorded at present
value at the time of the original charge in the amount of $1.6 million. The
additions to occupancy during the 16 weeks ended June 17, 2006 represent
interest accretion on future occupancy costs which were recorded at present
value at the time of the original charge in the amount of $1.1 million. The
additional charge to severance during fiscal 2005 of $1.3 million related
to individual severings as a result of the additional stores identified for
closures.
(3) Occupancy utilization of $9.5 million and $5.4 million for fiscal 2005 and
the 16 weeks ended June 17, 2006, respectively, represents payments made
for costs such as rent, common area maintenance, real estate taxes and
lease termination costs. Severance utilization of $2.4 million and $0.2
million for fiscal 2005 and the 16 weeks ended June 17, 2006, respectively,
represents payments made to terminated employees during the period.
22
(4) At each balance sheet date, we assess the adequacy of the balance to
determine if any adjustments are required as a result of changes in
circumstances and/or estimates. During fiscal 2005, we recorded an increase
of $9.2 million in occupancy accruals due to changes in our original
estimate of our future vacancy obligations for closed stores. We also
recorded a decrease of $0.04 million for the reversal of previously accrued
severance and benefits due to changes in individual severings and
associated benefit costs. During the first quarter of fiscal 2006, we
recorded adjustments for additional vacancy related costs for our
properties of $5.0 million due to changes in our estimation of such future
costs.
We paid $15.0 million of the total occupancy charges from the time of the
original charge through June 17, 2006 which was primarily for occupancy related
costs such as rent, common area maintenance, real estate taxes and lease
termination costs. We paid $2.6 million of the total net severance charges from
the time of the original charges through June 17, 2006, which resulted from the
termination of approximately 125 employees. The remaining occupancy liability of
$90.4 million relates to expected future payments under long term leases and is
expected to be paid out in full by 2021. The remaining severance liability of
$0.02 million relates to expected future payments for severance and benefits to
individual employees and will be fully paid out by February 24, 2007.
Included in the Statements of Consolidated Operations for the first quarters of
fiscal 2006 and 2005 are the sales and operating results of the 35 stores that
were closed in the Midwest. The results of these operations are as follows:
16 Weeks Ended
-------------------
June 17, June 18,
2006 2005
-------- --------
Sales $-- $88,477
=== =======
Loss from operations $-- $(8,867)
=== =======
At June 17, 2006 and February 25, 2006, approximately $22.1 million and $22.5
million of the liability was included in "Other accruals" and the remaining
amount was included in "Other non-current liabilities" on our Consolidated
Balance Sheets.
We have evaluated the liability balance of $90.4 million as of June 17, 2006
based upon current available information and have concluded that it is adequate.
We will continue to monitor the status of the vacant properties and adjustments
to the reserve balance may be recorded in the future, if necessary.
U.S DISTRIBUTION OPERATIONS AND WAREHOUSES
During fiscal 2005, our Company entered into definitive agreements, including an
Asset Purchase Agreement and a 15 year Supply Agreement, selling our U.S.
distribution operations and some warehouse facilities and related assets to C&S
Wholesale Grocers, Inc. The Asset Purchase Agreement included the assignment of
our leases in Central Islip, New York and Baltimore, Maryland, and a warranty
deed for our owned facilities in Dunmore, Pennsylvania. In the Supply Agreement,
C&S Wholesale Grocers, Inc. will supply our Company with all of our requirements
for groceries, perishables, frozen food and other merchandise in the product
categories carried by C&S Wholesale Grocers, Inc. The transition of our owned
warehouses and operations began in the second quarter of fiscal 2005 and was
completed during the fourth quarter of fiscal 2005.
23
The following table summarizes the activity to date related to the charges
recorded for the closing of these facilities.
Severance
and
Occupancy Benefits Total
--------- --------- --------
Original charge (1) $ -- $ 40,417 $ 40,417
Additions (2) 15,420 7,296 22,716
Utilization (3) (337) (43,597) (43,934)
Adjustments (4) -- (493) (493)
-------- -------- --------
Balance at
February 25, 2006 $ 15,083 $ 3,623 $ 18,706
Additions (2) 79 618 697
Utilization (3) (11,129) (977) (12,106)
Adjustment (4) 873 (77) 796
-------- -------- --------
Balance at
June 17, 2006 $ 4,906 $ 3,187 $ 8,093
======== ======== ========
(1) The original charge to severance and benefits during the first quarter of
fiscal 2005 of $40.4 million related to (i.) individual severings as well
as retention and productivity incentives that were accrued as earned of
$7.6 million and (ii.) costs for future obligations for early withdrawal
from multi-employer union pension plans of $32.8 million.
(2) The additions to occupancy during fiscal 2005 related to future occupancy
costs such as rent, common area maintenance and real estate taxes, and
future obligations for the warehouses sold to C&S Wholesale Grocers, Inc.
The additions to occupancy during the 16 weeks ended June 17, 2006
represent interest accretion on future occupancy costs which were recorded
at present value at the time of the original charge in the amount of $0.1
million. The additions to severance and benefits during fiscal 2005 and the
16 weeks ended June 17, 2006 represented charges related to additional
individual severings as well as retention and productivity incentives that
were accrued as earned.
(3) Occupancy utilization of $0.3 million and $11.1 million for fiscal 2005 and
the 16 weeks ended June 17, 2006, respectively, represents payments
associated with the closure of certain warehouses. Severance and benefits
utilization of $43.6 million and $1.0 million for fiscal 2005 and the 16
weeks ended June 17, 2006, respectively, represents payments made to
terminated employees during the period as well as payments made to pension
funds for early withdrawal from multi-employer union pension plans.
(4) At each balance sheet date, we assess the adequacy of the balance to
determine if any adjustments are required as a result of changes in
circumstances and/or estimates. During the fiscal 2005, we recorded
adjustments of $0.5 million primarily related to reversals of previously
accrued severance and benefits due to changes in individual severings and
associated benefit costs. During the first quarter of fiscal 2006, we
recorded adjustments for additional vacancy related costs for our
properties of $0.9 million due to changes in our estimation of such future
costs. During the first quarter of fiscal 2006, we recorded adjustments of
$0.1 million primarily related to reversals of previously accrued severance
and benefits due to changes in individual severings and associated benefit
costs.
We paid $11.5 million of the total occupancy charges from the time of the
original charge through June 17, 2006 which was primarily for occupancy related
costs such as rent, common area maintenance, real estate taxes and lease
termination costs. We paid $44.6 million of the total net severance and benefits
charges from the time of the original charges through June 17, 2006, which
resulted from the termination of approximately 140 employees. The remaining
occupancy liability of $4.9 million relates to expected future payments under
long term leases and is expected to be paid out in full by 2026. The remaining
severance and benefits liability of $3.2 million relates to expected future
payments for severance and benefits to individual employees and will be fully
paid out by February 23, 2008.
24
As of June 17, 2006 and February 25, 2006, approximately $0.4 and $1.4 million,
respectively, of the liability was included in "Accrued salaries, wages and
benefits," $1.5 and $11.3 million, respectively, of the liability was included
in "Other Accruals" and the remaining amount was included in "Other non-current
liabilities" on our Consolidated Balance Sheets.
We have evaluated the liability balance of $8.1 million as of June 17, 2006
based upon current available information and have concluded that it is adequate.
We will continue to monitor the status of the warehouses and adjustments to the
reserve balance may be recorded in the future, if necessary.
Our Company currently acquires a significant amount of our saleable inventory
from one supplier, C&S Wholesale Grocers, Inc. Although there are a limited
number of distributors that can supply our stores, we believe that other
suppliers could provide similar product on comparable terms. However, a change
in suppliers could cause a delay in distribution and a possible loss of sales,
which would affect operating results adversely.
9. RETIREMENT PLANS AND BENEFITS
DEFINED BENEFIT PLANS
We provide retirement benefits to certain non-union and union employees under
various defined benefit plans. Our defined benefit pension plans are
non-contributory and benefits under these plans are generally determined based
upon years of service and, for salaried employees, compensation. We fund these
plans in amounts consistent with the statutory funding requirements. The
components of net pension cost were as follows:
For the 16 Weeks Ended
------------------------------------
June 17, 2006 June 18, 2005
---------------- -----------------
U.S. Canada U.S. Canada
------- ------ ------- -------
Service cost $ 1,625 $-- $ 1,846 $ 3,039
Interest cost 3,482 -- 3,657 4,329
Expected return on plan assets (3,800) -- (4,130) (5,557)
Amortization of unrecognized net transition asset -- -- -- --
Amortization of unrecognized net prior service (gain) cost (55) -- (91) 190
Amortization of unrecognized net loss 50 -- 18 598
Administrative expenses and other 78 -- -- 92
------- --- ------- -------
Net pension cost $ 1,380 $-- $ 1,300 $ 2,691
======= === ======= =======
CONTRIBUTIONS
We previously disclosed in our consolidated financial statements for the year
ended February 25, 2006, that we expected to contribute $5.2 million in cash to
our defined benefit plans in fiscal 2006. As of June 17, 2006, we contributed
approximately $1.4 million to our defined benefit plans. We plan to contribute
approximately $3.8 million to our plans during the remainder of fiscal 2006.
POSTRETIREMENT BENEFITS
We provide postretirement health care and life benefits to certain union and
non-union employees. We recognize the cost of providing postretirement benefits
during employees' active service periods. We use
25
a December 31 measurement date for our postretirement benefits. The components
of net postretirement benefits (income) cost were as follows:
For the 16 Weeks Ended
-------------------------------
June 17, 2006 June 18, 2005
-------------- --------------
U.S. Canada U.S. Canada
----- ------ ----- ------
Service cost $ 114 $-- $ 104 $ 50
Interest cost 362 -- 370 179
Amortization of (gain) loss (69) -- (86) 78
Prior service cost (414) -- (414) (98)
----- --- ----- ----
Net postretirement benefits (income) cost $ (7) $-- $ (26) $209
===== === ===== ====
10. STOCK BASED COMPENSATION
During the first quarter of fiscal 2006, compensation expense related to
share-based incentive plans was $3.3 million, after tax, compared to $2.2
million during the first quarter of fiscal 2005. Included in share-based
compensation expense recorded during the first quarter of fiscal 2006 and fiscal
2005 was $0.5 million and $0.9 million, respectively, related to expensing of
stock options, $2.2 million and $1.2 million, respectively, relating to
expensing of restricted stock, and $0.6 and $0.1 million, respectively, relating
to expensing of common stock granted to our Board of Directors at the Annual
Meeting of Stockholders. There was no effect on the Consolidated Statement of
Cash Flows from the adoption of FAS 123R (revised 2004), "Share-Based Payment"
("SFAS 123R") as we adopted FAS 123R using the modified prospective application.
At June 17, 2006, we had two stock-based compensation plans. The general terms
of each plan, the method of estimating fair value for each plan and fiscal 2005
and 2006 activity is reported below.
I. The 1998 Long Term Incentive and Share Award Plan: This plan provides for
the grant of awards in the form of options, SAR's, restricted shares,
restricted share units, performance shares, performance units, dividend
equivalent, or other share based awards to our Company's officers and key
employees. The total number of shares available for issuance under this
plan is 8,000,000 subject to anti-dilution provisions. Options and SAR's
issued under this plan vest 25% on each anniversary date of issuance over a
four year period.
Performance restricted stock units issued under this plan during fiscal
2005 are earned based on our Company achieving in Fiscal 2007 a profit
after taxes, after adjusting for specific matters which our Company
considers to be of a non-operating nature, with an outlook for continued,
sustainable profitability on the same basis. The units will vest 50% based
on achievement of a net profit in fiscal 2007 and 50% based on achievement
of a net profit in fiscal 2008. However, if our Company achieves
profitability in fiscal 2006, the shares will be earned and vesting will
commence in fiscal 2006 in one-third increments, based on achievement of
profitability in each year and the outlook for continued, sustainable
profitability.
Performance restricted stock units issued under this plan during fiscal
2006 are earned based on our Company achieving certain operating targets in
Fiscal 2008 and are 100% vested in Fiscal 2008 upon achievement of those
targets.
26
The stock option awards under The 1998 Long Term Incentive and Share Award
Plan are granted at the fair market value of the Company's common stock at
the date of grant. Fair value calculated under SFAS 123, as amended,
"Accounting for Stock-Based Compensation" is used to recognize expense upon
adoption of SFAS 123R. Fair values for each grant were estimated using a
Black-Scholes valuation model which utilized assumptions as detailed in the
following table for expected life based upon historical option exercise
patterns, historical volatility for a period equal to the stock option's
expected life, and risk-free rate based on the U.S. Treasury constant
maturities in effect at the time of grant. During the first quarter ended
June 18, 2005, our Company did not grant any stock options under this plan.
The following assumptions were in place during the 16 weeks ended June 17,
2006:
16 weeks ended
June 17, 2006
--------------
Expected life 7 years
Volatility 56%
Risk-free interest rate 4.96%
Performance restricted stock units issued under The 1998 Long Term
Incentive and Share Award Plan are granted at the fair market value of the
Company's common stock at the date of grant and adjusted by an estimated
forfeiture rate.
Stock options
The following is a summary of the stock option activity during the first
quarter ended June 17, 2006:
Weighted
Weighted Average
Average Remaining Aggregate
Exercise Contractual Intrinsic
Shares Price Term (years) Value
--------- -------- ------------ ---------
Outstanding at February 25, 2006 1,534,385 $19.24
Adjustment for dividend* 371,995 --
Granted 86,430 27.71
Canceled or expired (92,297) 23.96
Exercised (295,298) 15.43
--------- ------
Outstanding at June 17, 2006 1,605,215 $15.67 4.9 $9,365
========= ====== === ======
Exercisable at:
June 17, 2006 1,231,674 $16.87 4.1 $5,706
=== ======
Nonvested at:
June 17, 2006 373,541 $11.70 7.7 $3,659
=== ======
The total intrinsic value of options exercised during the first quarter
ended June 17, 2006 was $4.0 million.
As of June 17, 2006, approximately $1.3 million, after tax, of total
unrecognized compensation expense related to unvested stock option awards
will be recognized over a weighted average period of 1.2 years.
The amount of cash received from the exercise of stock options was
approximately $4.6 million.
27
Performance Restricted Stock Units
During the first quarter of fiscal 2006, our Company granted 386,460 shares
of performance restricted stock units to selected employees for a total
grant date fair value of $10.7 million. Approximately $20.9 million of
unrecognized fair value compensation expense relating to all of our
performance restricted stock units is expected to be recognized through
fiscal 2009 based on estimates of attaining vesting criteria.
The following is a summary of the performance restricted stock units
activity during the first quarter ended June 17, 2006:
Weighted
Average
Exercise
Shares Price
--------- --------
Nonvested at February 25, 2006 1,285,000 $14.42
Adjustment for dividend* 339,369 --
Granted 386,460 27.68
Canceled or expired -- --
Exercised -- --
--------- ------
Nonvested at June 17, 2006 2,010,829 $14.53
========= ======
* As discussed in Note 3 - Special One Time Dividend, our Company
adjusted the number and/or price of all unexercised stock compensation
as of April 12, 2006, to ensure that an individual's right to purchase
stock at an aggregate value remained the same both before and after
the special one-time dividend payment. These adjustments had no impact
on stock compensation expense for the 16 weeks ended June 17, 2006.
II. 2004 Non-Employee Director Compensation Plan: This plan provides for the
annual grant of Company common stock equivalent to $45 to members of our
Board of Directors. The $45 grant of common stock shall be made on the
first business day following the Annual Meeting of Stockholders. The number
of shares of our Company's $1.00 common stock granted annually to each
non-employee Director will be based on the closing price of the common
stock on the New York Stock Exchange, as reported in the Wall Street
Journal on the date of grant. Only whole shares will be granted; any
remaining amounts will be paid in cash as promptly as practicable following
the date of grant.
11. INCOME TAXES
The income tax provision recorded for the 16 weeks ended June 17, 2006 and June
18, 2005 reflects our estimated expected annual tax rates applied to our
respective domestic and foreign financial results.
SFAS No. 109 "Accounting for Income Taxes" ("SFAS 109") provides that a deferred
tax asset is recognized for temporary differences that will result in deductible
amounts in future years and for carryforwards. In addition, SFAS 109 requires
that a valuation allowance be recognized if, based on existing facts and
circumstances, it is more likely than not that some portion or all of the
deferred tax asset will not be realized. Based upon our continued assessment of
the realization of our U.S. net deferred tax asset and our historic cumulative
losses, we concluded that it was appropriate to record a valuation allowance in
an amount that would reduce our net U.S. deferred tax asset to zero. For the 16
weeks ended June 17, 2006, and June 18, 2005, the valuation allowance was
decreased by $5.4 million and increased by $3.5 million, respectively. To the
extent that our U.S. operations generate sufficient taxable income in
28
future periods, we will reverse the income tax valuation allowance. In future
periods, we will continue to record a valuation allowance against net deferred
tax assets that are created by U.S. losses until such time as the certainty of
future tax benefits can be reasonably assured.
In October 2004, the U.S. government passed the "Homeland Investment Act" which
allows companies to repatriate cash balances from their controlled foreign
subsidiaries at a reduced tax rate. This is achieved by permitting a one time
85% dividends received deduction. Our Company completed the sale of our Canadian
subsidiary to Metro, Inc. during fiscal 2005. As a result of this transaction,
our Company repatriated $949.0 million from our foreign subsidiaries, of which
$500.0 million is intended to qualify for the 85% dividends received deduction.
Until such time as the taxing authorities have affirmed the adequacy of our
Company's Domestic Reinvestment Plan, we have recorded a tax provision of $98.1
million for the potential disallowance of the 85% dividend received deduction.
This amount was recorded in "(Provision for) benefit from income taxes" in our
Consolidated Statements of Operations for fiscal 2005 and in "Other non-current
liabilities" in our Consolidated Balance Sheet at February 25, 2006. During the
first quarter ended June 17, 2006, this tax provision was reduced by $11.3
million to $86.8 million as we continue to experience operating losses which
decreases the overall tax provision previously recorded during fiscal 2005. This
reduction was recorded in "Benefit from (provision for) income taxes" in our
Consolidated Statements of Operations for the 16 weeks ended June 17, 2006. The
$86.8 million was recorded in "Other non-current liabilities" in our
Consolidated Balance Sheet at June 17, 2006. This amount is subject to further
adjustment based upon several factors, including our Company's operating results
and the availability of foreign tax credits, which were not estimable at June
17, 2006. Our Company intends to complete a foreign tax credit analysis during
fiscal 2006.
For the first quarter of fiscal 2006, our effective income tax rate benefit of
64.0% changed from the effective income tax rate provision of 18.5% in the first
quarter of fiscal 2005 as follows:
16 Weeks Ended
-------------------------------------------
June 17, 2006 June 18, 2005
------------------- ---------------------
Tax Effective Tax Effective
Benefit Tax Rate Provision Tax Rate
------- --------- --------- ---------
United States $9,659 (64.0%) $ (1,455) 1.9%
Canada -- -- (12,481) 16.6%
------ ----- -------- ----
$9,659 (64.0%) $(13,936) 18.5%
====== ===== ======== ====
The change in our effective tax rate was primarily due to (i.) the recognition
of tax benefits during the 16 weeks ended June 17, 2006 as we continue to
experience operating losses and these operating losses decrease the overall tax
provision previously recorded during the second quarter of fiscal 2005 in
connection with our Company's Domestic Reinvestment Plan as discussed above and
the sale of our Canadian operations, (ii.) the decrease in our valuation
allowance as discussed above, (iii.) the tax benefit from not providing deferred
taxes on the undistributed earnings of our investment in Metro, Inc., and (iv.)
the absence of a tax provision that was recorded for our Canadian operations
during the 16 weeks ended June 18, 2005 that was not recorded during the 16
weeks ended June 17, 2006 due to the sale of our Canadian operations during the
second quarter of fiscal 2005.
At June 17, 2006 and February 25, 2006, we had a net current deferred tax asset
which is included in "Prepaid expenses and other current assets" on our
Consolidated Balance Sheets totaling $50.9 million and $60.0 million,
respectively, and a net non-current deferred tax liability which is included in
"Other non-current liabilities" on our Consolidated Balance Sheets totaling
$50.9 million and $60.0 million, respectively.
29
12. OPERATING SEGMENTS
Operating segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and in
assessing performance. Our chief operating decision maker is our President and
Chief Executive Officer.
During the 16 weeks ended June 17, 2006 we operated in two reportable segments:
United States and our investment in Metro, Inc. During the 16 weeks ended June
18, 2005, we operated in two reportable segments: United States and Canada. Our
United States and Canadian segments are comprised of retail supermarkets. Our
equity investment represents our economic interest in Metro, Inc. and is
required to be reported as an operating segment in accordance with SFAS 131,
"Disclosure about Segments of an Enterprise and Related Information" as our
investment is greater than 10% of our Company's combined assets of all operating
segments and we have significant influence over substantive operating decisions
through our membership on Metro, Inc.'s Board of Directors and its committees
and information technology services agreement. The accounting policies for these
segments are the same as those described in the summary of significant
accounting policies included in our Fiscal 2005 Annual Report. We measure
segment performance based upon income (loss) from operations.
Interim information on segments is as follows:
16 Weeks Ended
-----------------------------
June 17, 2006 June 18, 2005
------------- -------------
Sales
United States $2,126,895 $2,229,918
Canada* -- 1,153,715
---------- ----------
Total Company $2,126,895 $3,383,633
========== ==========
Sales by category
Grocery (1) $1,438,882 $2,200,702
Meat (2) 414,495 696,287
Produce (3) 268,095 486,644
Other (4) 5,423 --
---------- ----------
Total Company $2,126,895 $3,383,633
========== ==========
(1) The grocery category includes grocery, frozen foods, dairy, general
merchandise/health and beauty aids, liquor, pharmacy and fuel.
(2) The meat category includes meat, deli, bakery and seafood.
(3) The produce category includes produce and floral.
(4) Other includes sales from an information technology services agreement with
Metro, Inc.
Depreciation and amortization
United States $54,947 $ 60,980
Canada* -- 10,895
------- --------
Total Company $54,947 $ 71,875
======= ========
(Loss) income from operations
United States $(5,053) $(77,837)
Canada* -- 39,697
------- --------
Total Company $(5,053) $(38,140)
======= ========
30
16 Weeks Ended
-----------------------------
June 17, 2006 June 18, 2005
------------- -------------
(Loss) income from continuing operations
before income taxes
United States $(23,032) $(107,973)
Canada* -- 32,771
Equity investment in Metro, Inc. 7,947 --
-------- ---------
Total Company $(15,085) $ (75,202)
======== =========
Capital expenditures
United States $ 68,129 $ 39,634
Canada* -- 30,186
-------- ---------
Total Company $ 68,129 $ 69,820
======== =========
June 17, 2006 February 25, 2006
------------- -----------------
Total assets
United States $1,839,901 $2,160,109
Canada * -- --
Equity investment in Metro, Inc. 356,486 338,756
---------- ----------
Total Company $2,196,387 $2,498,865
========== ==========
* We sold our Canadian operations during fiscal 2005; thus, we have included
the operating results of our Canadian subsidiary through the date of its
sale.
13. INDEBTEDNESS
During fiscal 2005, we entered into a new, cash collateralized, Letter of Credit
Agreement that enables us to issue letters of credit up to $200 million. We also
secured a $150 million Revolver with four lenders enabling us to borrow funds on
a revolving basis for working capital loans and letters of credit. The Revolver
includes a $100 million accordion feature which gives us the ability to increase
commitments from $150 million to $250 million. Effective April 4, 2006, we
exercised the accordion option and increased our commitments to $250 million.
At June 17, 2006 and February 25, 2006, there were $70.5 million and nil,
respectively, in outstanding borrowings under our Revolver.
14. HEDGE OF NET INVESTMENT IN FOREIGN OPERATIONS
From time to time, we may enter hedging agreements in order to manage risks
incurred in the normal course of business including forward exchange contracts
to manage our exposure to fluctuations in foreign exchange rates.
During the first quarter of fiscal 2005, we entered into a six month currency
exchange forward contract totaling $900 million Canadian dollar notional value
to hedge our net investment in our Canadian foreign operation against adverse
movements in exchange rates. Our Company measures ineffectiveness based upon the
change in forward exchange rates.
The effective portion of this net investment hedge contract resulted in a loss
of approximately $8.3 million, after tax, as of June 18, 2005, and was
recognized in our Consolidated Balance Sheet in the
31
accumulated other comprehensive loss (cumulative translation adjustment)
component of stockholders' equity. In addition, the amount excluded from the
measure of effectiveness on this net investment hedge amounted to $2.9 million,
before income taxes, and was recorded as "Store operating, general and
administrative expense" in our Consolidated Statements of Operations for the
first quarter ended June 18, 2005.
15. COMMITMENTS AND CONTINGENCIES
Antitrust Class Action Litigation
In connection with a settlement reached in the VISA/Mastercard antitrust class
action litigation, our Company is entitled to a portion of the settlement fund
that will be distributed to class members. Pursuant to our initial review of our
historical records as well as estimates provided by the Claims Administrator, we
recorded an estimated pretax recovery of $1.5 million as a credit to "Selling,
general and administrative expense" in our Consolidated Statements of Operations
during fiscal 2005.
On June 29, 2006, our Company received a cash payment of $1.6 million for our
portion of the settlement funds for this class action litigation. During the
remainder of fiscal 2006, we will continue to work with the Claims Administrator
to ensure that any additional monies owed to our Company in connection with this
litigation are received. This process may result in additional recoveries being
recorded in future periods.
Other
We are subject to various legal proceedings and claims, either asserted or
unasserted, which arise in the ordinary course of business. We are also subject
to certain environmental claims. While the outcome of these claims cannot be
predicted with certainty, Management does not believe that the outcome of any of
these legal matters will have a material adverse effect on our consolidated
results of operations, financial position or cash flows.
32
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
The following Management's Discussion and Analysis is intended to help the
reader understand the financial position, operating results, and cash flows of
The Great Atlantic and Pacific Tea Company, Inc. It should be read in
conjunction with our financial statements and the accompanying notes ("Notes").
It discusses matters that Management considers relevant to understanding the
business environment, financial position, results of operations and our
Company's liquidity and capital resources. These items are presented as follows:
o Basis of Presentation - a discussion of our Company's results during the
first quarter of fiscal 2006.
o Overview - a general description of our business; the value drivers of our
business; measurements; opportunities; challenges and risks; and
initiatives.
o Outlook - a discussion of certain trends or business initiatives for the
remainder of fiscal 2006 that Management wishes to share with the reader to
assist in understanding the business.
o Review of Continuing Operations and Liquidity and Capital Resources -- a
discussion of results for the 16 weeks ended June 17, 2006 compared to the
16 weeks ended June 18, 2005; significant business initiatives; current and
expected future liquidity; and the impact of various market risks on our
Company.
o Market Risk - a discussion of the impact of market changes on our
consolidated financial statements.
o Critical Accounting Estimates -- a discussion of significant estimates made
by Management.
o Impact of New Accounting Pronouncements - a discussion of authoritative
pronouncements that have been or will be adopted by our Company.
BASIS OF PRESENTATION
The accompanying consolidated financial statements of The Great Atlantic &
Pacific Tea Company, Inc. for the 16 weeks ended June 17, 2006 and June 18, 2005
are unaudited and, in the opinion of management, contain all adjustments that
are of a normal and recurring nature necessary for a fair statement of financial
position and results of operations for such periods. The consolidated financial
statements should be read in conjunction with the consolidated financial
statements and related notes contained in our Fiscal 2005 Annual Report to
Stockholders on Form 10-K. Interim results are not necessarily indicative of
results for a full year.
The consolidated financial statements include the accounts of our Company, all
majority-owned subsidiaries, and franchise operations.
33
OVERVIEW
The Great Atlantic & Pacific Tea Company, Inc., based in Montvale, New Jersey,
operates conventional supermarkets, combination food and drug stores and
discount food stores in 9 U.S. states and the District of Columbia. Our
Company's business consists strictly of our retail operations, which totaled 405
stores as of June 17, 2006.
Our United States retail operations are organized in three regions: North
Region, operating A&P supermarkets in New York and Northern New Jersey, The Food
Emporium in Westchester County, N.Y, A&P/Super Foodmart stores in Connecticut,
and all Food Basics discount stores; Central Region, operating all Waldbaum's
supermarkets, The Food Emporium in Manhattan, and the Farmer Jack supermarkets
in Michigan; and South Region, operating Super Fresh supermarkets in Baltimore
and Philadelphia, A&P supermarkets in Central New Jersey and Sav-A-Center
supermarkets in the greater New Orleans market.
A&P's operating results continued to improve in the Fiscal 2006 1st quarter, as
we remained focused on executing our ongoing operating, merchandising, store
development and cost reduction strategies. Those efforts yielded ongoing
comparable store sales improvements and the realization of targeted cost
savings, producing strong increases in operating income.
Alongside the fundamental retail improvements that remain in progress, our
Company launched additional examples of our Fresh store format in Baltimore as
well as in key northeastern seashore locations based on our successful Midland
Park, New Jersey prototype. Each conversion to the Fresh concept has generated
sharply increased sales overall, and a significant shift to greater fresh
category distribution, further boosting bottom line store performance.
Fresh store development, combined with our evolving discount Food Basics format,
and the upgraded gourmet Food Emporium offer to be unveiled later this year,
reflect the comprehensive, three-tier marketing thrust that will materialize
over the next three years.
In Michigan, we energized our Farmer Jack operations with a new marketing
campaign, rekindling that chain's traditional value-plus-quality proposition in
our advertising and merchandising. This initiative remains in its early stage,
but has generated renewed interest and enthusiasm among Detroit area consumers
and media as well as our Farmer Jack associates.
Across the business, we maintained the pace of overall, fundamental improvement.
Merchandising execution combined elevated customer appeal with increased buying
and selling efficiency; while in operations, we continued to enforce best
practices, which likewise improved both customer service and cost-effectiveness.
Those efforts supported the continuation of aggressive weekly ad features, and
the ongoing improvement of our every-day pricing levels. Having completed the
transition of our purchasing and distribution to our logistics supplier, C&S
Wholesale Grocers, we are now achieving the substantial annual savings targeted
prior to the change. We continue to work with C&S to optimize service levels and
in-stock performance as we drive throughput at retail.
On the administrative side, we realized the cost savings identified by our
previous reorganization initiatives, and have now established the reduced cost
basis that will be an ongoing contributor to improved operating results going
forward.
34
OUTLOOK
Our objective is to remain focused on the strategic elements that have driven
our improvement thus far, thereby remaining on track to achieve overall
profitability in Fiscal 2007 as planned.
With our organization essentially in place, our cost structure reduced, and our
logistics transformation completed, we are redoubling our efforts behind the
strategies driving sales and earnings improvement. Accordingly, the execution of
our marketing and retail development plans will continue to be high priorities,
as will the continued cost control disciplines we have established.
Key elements include the following:
o Move forward with the conversion of additional locations to the Fresh
format;
o Complete the fine-tuning of our evolving discount Food Basics concept and
proceed with its rollout to appropriate locations;
o Commence the development of our new generation Gourmet concept, for
introduction later this year under The Food Emporium banner in New York
City;
o Continue to develop and focus our new Farmer Jack marketing initiatives in
Michigan;
o Continue to improve our every-day grocery pricing and value image in all
markets, through more efficient buying and distribution, and innovative
marketing and promotion techniques.
o Continue to deliver comprehensive training to the majority of our stores
associates in Fiscal 2006, as we roll out our "Make It Personal" customer
service program across our Company.
Supporting those development efforts is ongoing adherence to cost control, and
further reduction wherever possible without compromising the growth of our
business. We will continue to seek and optimize additional means of improving
labor productivity in cooperation with our people and their labor unions, and by
seeking all reasonable opportunities to lower administrative, advertising,
occupancy and other operating expenses.
In summary, we are encouraged by the meaningful operating improvement achieved
over the past three quarters. As a result, we are increasingly confident that
our strategic execution will lead us to our profitability goal in Fiscal 2007.
Various factors could cause us to fail to achieve these goals. These include,
among others, the following:
o Actions of competitors could adversely affect our sales and future profits.
The grocery retailing industry continues to experience fierce competition
from other food retailers, super-centers, mass merchandisers, warehouse
clubs, drug stores, dollar stores and restaurants. Our continued success is
dependent upon our ability to effectively compete in this industry and to
reduce operating expenses, including managing health care and pension costs
contained in our collective bargaining agreements. The competitive
practices and pricing in the food industry generally and particularly in
our principal
35
markets may cause us to reduce our prices in order to gain or maintain
share of sales, thus reducing margins.
o Changes in the general business and economic conditions in our operating
regions, including the rate of inflation, population growth, the rising
prices of oil and gas, the nature and extent of continued consolidation in
the food industry and employment and job growth in the markets in which we
operate, may affect our ability to hire and train qualified employees to
operate our stores. This would negatively affect earnings and sales growth.
General economic changes may also affect the shopping habits and buying
patterns of our customers, which could affect sales and earnings. We have
assumed economic and competitive situations will not worsen in fiscal 2006
and 2007. However, we cannot fully foresee the effects of changes in
economic conditions, inflation, population growth, the rising prices of oil
and gas, customer shopping habits and the consolidation of the food
industry on our business.
o Our capital expenditures could differ from our estimate if we are
unsuccessful in acquiring suitable sites for new stores, or if development
and remodel costs vary from those budgeted.
o Our ability to achieve our profit goals will be affected by (i.) our
success in executing category management and purchasing programs that we
have underway, which are designed to improve our gross margins and reduce
product costs while making our product selection more attractive to
consumers, (ii.) our ability to achieve productivity improvements and
shrink in our stores, (iii.) our success in generating efficiencies in our
supporting activities, and (iv.) our ability to eliminate or maintain a
minimum level of supply and/or quality control problems with our vendors.
o The vast majority of our employees are members of labor unions. While we
believe that our relationships with union leaderships and our employees are
satisfactory, we operate under collective bargaining agreements which
periodically must be renegotiated. In the coming year, we have several
contracts expiring and under negotiation. In each of these negotiations
rising health care and pension costs will be an important issue, as will
the nature and structure of work rules. We are hopeful, but cannot be
certain, that we can reach satisfactory agreements without work stoppages
in these markets. However, the actual terms of the renegotiated collective
bargaining agreements, our future relationships with our employees and/or a
prolonged work stoppage affecting a substantial number of stores could have
a material effect on our results.
o The amount of contributions made to our pension and multi-employer plans
will be affected by the performance of investments made by the plans and
the extent to which trustees of the plans reduce the costs of future
service benefits.
o Our Company is currently required to acquire a significant amount of our
saleable inventory from one supplier, C&S Wholesale Grocers, Inc. Although
there are a limited number of distributors that can supply our stores, we
believe that other suppliers could provide similar product on comparable
terms. However, a change in suppliers could cause a delay in distribution
and a possible loss of sales, which would affect operating results
adversely.
o We have estimated our exposure to claims, administrative proceedings and
litigation and believe we have made adequate provisions for them, where
appropriate. Unexpected outcomes in both the costs and effects of these
matters could result in an adverse effect on our earnings.
36
Other factors and assumptions not identified above could also cause actual
results to differ materially from those set forth in the forward-looking
information. Accordingly, actual events and results may vary significantly from
those included in or contemplated or implied by forward-looking statements made
by us or our representatives.
RESULTS OF CONTINUING OPERATIONS AND LIQUIDITY AND CAPITAL RESOURCES
Our consolidated financial information presents the loss related to our
operations of discontinued businesses separate from the results of our
continuing operations. The discussion and analysis that follows focus on
continuing operations.
We sold our Canadian operations to Metro, Inc. at the close of business on
August 13, 2005. Therefore, comparative information relating to our Canadian
business that follows did not include any weeks during the first quarter ended
June 17, 2006, compared to 16 weeks during the first quarter ended June 18,
2005, respectively.
16 WEEKS ENDED JUNE 17, 2006 COMPARED TO THE 16 WEEKS ENDED JUNE 18, 2005
OVERALL
Sales for the first quarter of fiscal 2006 were $2.1 billion, compared with $3.4
billion in the first quarter of fiscal 2005; comparable store sales, which
includes stores that have been in operation for two full fiscal years and
replacement stores, increased 1.5%. Loss from continuing operations decreased
from $89.1 million for the first quarter of fiscal 2005 to $5.4 million for the
first quarter of fiscal 2006. Net loss per share - basic & diluted for the first
quarter of fiscal 2006 was $0.15 compared to net loss per share - basic &
diluted of $2.28 for the first quarter of fiscal 2005.
16 Weeks 16 Weeks
Ended Ended Favorable /
June 17, 2006 June 18, 2005 (Unfavorable) % Change
------------- ------------- ------------- ---------
Sales $2,126.9 $3,383.6 $(1,256.7) (37.1%)
Increase (decrease) in comparable
store sales 1.5% (0.3%) NA NA
Loss from continuing operations (5.4) (89.1) 83.7 93.9%
Loss from discontinued operations (0.7) (0.1) (0.6) >(100.0%)
Net loss (6.1) (89.2) 83.1 93.2%
Net loss per share (0.15) (2.28) 2.13 93.4%
37
SALES
Sales for the first quarter of fiscal 2006 of $2,126.9 million decreased
$1,256.7 million or 37.1% from sales of $3,383.6 million for first quarter of
fiscal 2005. The lower sales were due to a decrease in U.S. sales of $103.0
million and a decrease in Canadian sales of $1,153.7 million. The following
table presents sales for each of our operating segments for the first quarter of
fiscal 2006 and the first quarter of fiscal 2005:
16 Weeks Ended 16 Weeks Ended
June 17, 2006 June 18, 2005 Decrease % Change
-------------- -------------- --------- --------
United States $2,126.9 $2,229.9 $ (103.0) (4.6)
Canada -- 1,153.7 (1,153.7) (100.0)
-------- -------- --------- ------
Total $2,126.9 $3,383.6 $(1,256.7) (37.1%)
======== ======== ========= ======
The following details the dollar impact of several items affecting the decrease
in sales by operating segment from the first quarter of fiscal 2005 to the first
quarter of fiscal 2006:
Impact of Impact of Comparable
New Closed Store
Stores Stores Sales Other Total
--------- --------- ---------- --------- ---------
United States $10.0 $(150.6) $32.2 $ 5.4 $ (103.0)
Canada -- -- -- (1,153.7) (1,153.7)
----- ------- ----- --------- ---------
Total $10.0 $(150.6) $32.2 $(1,148.3) $(1,256.7)
===== ======= ===== ========= =========
The decrease in U.S. sales was primarily attributable to the closing of 50
stores since the beginning of fiscal 2005, of which 1 was closed in the first
quarter of fiscal 2006, decreasing sales by $150.6 million. This decrease was
partially offset by the opening or reopening of 3 new stores since the beginning
of fiscal 2005, of which 1 was opened in the first quarter of fiscal 2006,
increasing sales by $10.0 million, the increase in comparable store sales for
the first quarter of fiscal 2006 of $32.2 million or 1.5% as compared with the
first quarter of fiscal 2005, and the increase in sales relating to an
information technology services agreement with Metro, Inc. of $5.4 million.
Included in the 50 stores closed since the beginning of fiscal 2005 were 35
stores closed as part of the asset disposition initiatives as discussed in Note
8 of our Consolidated Financial Statements.
The decrease in Canadian sales of $1,153.7 million was due to the sale of our
Canadian operations during the second quarter of fiscal 2005 which resulted in
the inclusion of zero weeks of sales during the first quarter of fiscal 2006 as
compared to 16 weeks during the first quarter of fiscal 2005.
Average weekly sales per supermarket for the U.S. were approximately $340,900
for the first quarter of fiscal 2006 versus $322,800 for the corresponding
period of the prior year, an increase of 5.6% primarily due to the impact of
closing smaller stores and positive comparable store sales.
GROSS MARGIN
The following table presents gross margin dollar results and gross margin as a
percentage of sales by operating segment for the first quarter of fiscal 2006 as
compared to the first quarter of fiscal 2005. Gross margin as a percentage of
sales increased 229 basis points to 30.01% for the first quarter of fiscal 2006
from 27.72% for the first quarter of fiscal 2005. This 229 basis point increase
was caused by the sale of our
38
Canadian operations which had a lower gross margin rate. We believe the impact
on margin for changes in costs and special reductions was not significant.
16 Weeks Ended 16 Weeks Ended
June 17, 2006 June 18, 2005
----------------------------- -----------------------------
Gross Margin Rate to Sales% Gross Margin Rate to Sales%
------------ -------------- ------------ --------------
United States $638.2 30.01% $653.7 29.32%
Canada -- -- 284.3 24.64
------ ----- ------ -----
Total $638.2 30.01% $938.0 27.72%
====== ===== ====== =====
The following table details the dollar impact of several items affecting the
gross margin dollar increase (decrease) from the first quarter of fiscal 2005 to
the first quarter of fiscal 2006:
Sales Volume Gross Margin Rate Other Total
------------ ----------------- ------- -------
United States $(30.1) $14.6 $ -- $ (15.5)
Canada -- -- (284.3) (284.3)
------ ----- ------- -------
Total $(30.1) $14.6 $(284.3) $(299.8)
====== ===== ======= =======
STORE OPERATING, GENERAL AND ADMINISTRATIVE EXPENSE
The following table presents store operating, general and administrative expense
("SG&A"), by reportable operating segment, in dollars and as a percentage of
sales for the first quarter of fiscal 2006 compared with the first quarter of
fiscal 2005. SG&A expense was $643.2 million or 30.24% for the first quarter of
fiscal 2006 as compared to $976.1 million or 28.85% for the first quarter of
fiscal 2005.
16 Weeks Ended 16 Weeks Ended
June 17, 2006 June 18, 2005
----------------------- -----------------------
SG&A Rate to Sales% SG&A Rate to Sales%
------ -------------- ------ --------------
United States $643.2 30.24% $731.5 32.80%
Canada -- -- 244.6 21.20
------ ----- ------ -----
Total $643.2 30.24% $976.1 28.85%
====== ===== ====== =====
Included in SG&A in the U.S. for the first quarter of fiscal 2006 were certain
charges as follows:
o costs relating to the closing of our owned warehouses in Edison, New Jersey
and Bronx, New York of $4.4 million (21 basis points) that will not be sold
as part of the sale of our U.S. distribution operations and some warehouse
facilities and related assets to C&S Wholesale Grocers as discussed in Note
8 - Asset Disposition Initiatives;
o costs relating to closures of stores in the Midwest as discussed in Note 8
- Asset Disposition Initiatives of $5.2 million (24 basis points);
o costs relating to the consolidation of our operating offices in line with
our smaller operations in the U.S. of $3.3 million (16 basis points); and
o costs relating to a voluntary labor buyout program in the South Region of
$3.7 million (17 basis points)
Partially offset by:
39
o net gains on real estate activity of $8.7 million (41 basis points) during
the first quarter of fiscal 2006.
SG&A in the U.S. for the first quarter of fiscal 2005 also included certain
charges as follows:
o costs relating to the closing of our owned warehouses in Edison, New Jersey
and Bronx, New York of $47.0 million (210 basis points) that will not be
sold as part of the sale of our U.S. distribution operations and some
warehouse facilities and related assets to C&S Wholesale Grocers as
discussed in Note 8 - Asset Disposition Initiatives;
o costs relating to the closure of stores in the Midwest of $14.8 million (67
basis points) as discussed in Note 8 - Asset Disposition Initiatives; and
o costs relating to the settlement of our net investment hedge as discussed
in Note 14 - Hedge of Net Investment in Foreign Operations of $2.9 million
(13 basis points)
Partially offset by:
o net gains on real estate activity of $15.4 million (69 basis points) during
the first quarter of fiscal 2005.
Excluding the items listed above, SG&A within our core U.S. operations as a
percentage of sales decreased by 72 basis points during the first quarter of
fiscal 2006 as compared to the first quarter of fiscal 2005 primarily due to
the continued focus on discretionary spend.
The decrease in SG&A in Canada of $244.6 million was due to the sale of our
Canadian operations during the second quarter of fiscal 2005 which resulted in
the inclusion of zero weeks of costs during the first quarter of fiscal 2006 as
compared to 16 weeks during the first quarter of fiscal 2005.
During the 16 weeks ended June 17, 2006 and June 18, 2005, we recorded
impairment losses on long-lived assets of $2.3 million and $6.4 million,
respectively, as follows:
16 weeks ended 16 weeks ended
June 17, 2006 June 18, 2005
-------------- -------------------
U.S. U.S. Canada Total
-------------- ---- ------ -----
Impairments due to closure or conversion
in the normal course of business $1.2 $ -- $0.5 $0.5
Impairments related to our asset
disposition initiatives (1) 1.1 5.9 -- 5.9
---- ---- ---- ----
Total impairments $2.3 $5.9 $0.5 $6.4
==== ==== ==== ====
(1) Refer to Note 8 - Asset Disposition Initiatives
The effects of changes in estimates of useful lives were not material to ongoing
depreciation expense.
If current operating levels do not continue to improve, there may be additional
future impairments on long-lived assets, including the potential for impairment
of assets that are held and used.
40
INTEREST EXPENSE
Interest expense of $22.2 million for the first quarter of fiscal 2006 decreased
from the prior year amount of $36.1 million due primarily to (i.) the repurchase
of the majority of our 7.75% Notes due April 15, 2007 and our 9.125% Senior
Notes due December, 15, 2011 during the second quarter of fiscal 2005 resulting
in a reduction in interest expense of $10.1 million, and (ii.) the absence of
interest expense relating to our Canadian operations that was recorded during
the 16 weeks ended June 18, 2005 of $5.6 million but not recorded during the 16
weeks ended June 17, 2006 as a result of its sale.
INCOME TAXES
The benefit from income taxes from continuing operations for the first quarter
of fiscal 2006 was $9.7 million compared to a provision for income taxes for the
first quarter of fiscal 2005 of $13.9 million (a $1.4 million provision for our
U.S. operations and a $12.5 million provision for our Canadian operations).
Consistent with prior year, we continue to record a valuation allowance against
our U.S. net deferred tax assets.
For the first quarter of fiscal 2006, our effective income tax rate benefit of
64.0% changed from the effective income tax rate provision of 18.5% in the first
quarter of fiscal 2005 as follows:
16 Weeks Ended
-------------------------------------------
June 17, 2006 June 18, 2005
------------------- ---------------------
Tax Effective Tax Effective
Benefit Tax Rate Provision Tax Rate
------- --------- --------- ---------
United States $9,659 (64.0%) $ (1,455) 1.9%
Canada -- -- (12,481) 16.6%
------ ----- -------- ----
$9,659 (64.0%) $(13,936) 18.5%
====== ===== ======== ====
The change in our effective tax rate was primarily due to (i.) the recognition
of tax benefits during the 16 weeks ended June 17, 2006 as we continue to
experience operating losses and these operating losses decrease the overall tax
provision previously recorded during the second quarter of fiscal 2005 in
connection with our Company's Domestic Reinvestment Plan and the sale of our
Canadian operations, (ii.) the decrease in our valuation allowance, (iii.) the
tax benefit from not providing deferred taxes on the undistributed earnings of
our investment in Metro, Inc., and (iv.) the absence of a tax provision that was
recorded for our Canadian operations during the 16 weeks ended June 18, 2005
that was not recorded during the 16 weeks ended June 17, 2006 due to the sale of
our Canadian operations during the second quarter of fiscal 2005.
DISCONTINUED OPERATIONS
Beginning in the fourth quarter of fiscal year 2002 and in the early part of the
first quarter of fiscal 2003, we decided to sell our operations located in
Northern New England and Wisconsin, as well as our Eight O'Clock Coffee
business. These asset sales are now complete.
The loss from operations of discontinued businesses, net of tax, for the first
quarter of fiscal 2006 of $0.7 million increased from the prior year amount of
$0.1 million for the first quarter of fiscal 2005 primarily due to additional
vacancy costs that were recorded in the first quarter of fiscal 2006 due to
changes in our estimation of such future costs.
41
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS
The following table presents excerpts from our Consolidated Statement of Cash
Flows:
16 weeks ended
-----------------------------
June 17, 2006 June 18, 2005
------------- -------------
Net cash (used in) provided by operating activities $ (2,768) $ 1,231
--------- --------
Net cash provided by (used in) investing activities $ 89,460 $(38,247)
--------- --------
Net cash used in by financing activities $(219,370) $ (3,410)
--------- --------
Net cash used in operating activities of $2.8 million for the 16 weeks ended
June 17, 2006 primarily reflected our net loss of $6.1 million, adjusted for
non-cash charges for (i.) depreciation and amortization of $54.9 million, and
(ii.) our asset disposition initiatives of $7.3 million, partially offset by
(iii.) gains on the disposal of owned property of $9.7 million, (iv.) income tax
benefit relating to the sale of our Canadian operations of $11.3 million, and
(v.) our equity in earnings of Metro, Inc. of $7.9 million, and a decrease in
accounts receivable of $44.0 million partially offset by a decrease in accrued
salaries, wages and benefits, and taxes of $19.4 million, a decrease in other
accruals of $47.3 million and a decrease in non-current liabilities of $14.2
million due mainly to a decrease in closed store accruals. Refer to Working
Capital below for discussion of changes in working capital items. Net cash flow
provided by operating activities of $1.2 million for the 16 weeks ended June 18,
2005 primarily reflected our net loss of $89.2 million, adjusted for non-cash
charges for (i.) depreciation and amortization of $71.9 million, (ii.) our asset
disposition initiatives of $63.1 million, partially offset by (iii.) gains on
the disposal of owned property of $15.4 million, a decrease in accounts
receivable of $16.5 million partially offset by an increase in inventories of
$20.7 million, a decrease in accrued salaries, wages and benefits, and taxes of
$19.1 million and a decrease in non-current liabilities of $11.4 million due
mainly to a decrease in closed store accruals.
Net cash provided by investing activities of $89.5 million for the 16 weeks
ended June 17, 2006 primarily reflected cash received from the sale of certain
of our assets of $10.4 million, a decrease in restricted cash of $76.8 million,
and net sales of marketable securities of $70.7 million partially offset by
property expenditures totaling $68.1 million, which included 1 new supermarket,
6 major remodels and 27 minor remodels. For the remainder of fiscal 2006, we
have planned capital expenditures of approximately $150 million, which relate
primarily to opening up to 5 new supermarkets under the Fresh format, enlarging
or remodeling up to 35 supermarkets to the new Fresh format, converting up to 10
stores to the new Food Basics(R) format, and converting 1 supermarket to the new
Gourmet format. We currently expect to close up to 3 stores during the remainder
of fiscal 2006. Net cash flow used in investing activities of $38.2 million for
the 16 weeks ended June 18, 2005 primarily reflected property expenditures
totaling $69.8 million, which included 1 new supermarket and 25 major remodels,
partially offset by cash received from the sale of certain of our assets of
$31.6 million.
Net cash used in financing activities of $219.4 million for the 16 weeks ended
June 17, 2006 primarily reflected principal payments on long term borrowings of
$217.8 million, principal payments on capital leases of $2.0 million, and
dividends paid of $299.1 million partially offset by proceeds from long-term
borrowings of $288.3 million, an increase in book overdrafts of $7.6 million and
proceeds from the exercise of stock options of $4.6 million. Net cash flow used
in financing activities of $3.4 million for the
42
16 weeks ended June 18, 2005 primarily reflected principal payments on long term
borrowings of $14.5 million and principal payments on capital leases of $2.2
million partially offset by proceeds from the exercise of stock options of $11.8
million.
We operate under an annual operating plan which is reviewed and approved by our
Board of Directors and incorporates the specific operating initiatives we expect
to pursue and the anticipated financial results of our Company. Our plan for
fiscal 2006 at this time has been approved and we believe that our present cash
resources, including invested cash on hand as well as our marketable securities,
available borrowings from our Revolver and other sources, are sufficient to meet
our needs. In addition, effective April 4, 2006, aggregate commitments under our
Revolver, dated as of November 15, 2005, were increased by $100 million
resulting in total commitments of $250 million.
On April 25, 2006, our Company paid a special one-time dividend to our
shareholders of record on April 17, 2006 equal to $7.25 per share. This dividend
payout totaling $299.1 million was considered a return of capital to our
shareholders and accordingly was recorded as a reduction of "Additional paid in
capital" in our Consolidated Balance Sheets at June 17, 2006. The transaction
was funded primarily by cash available on the balance sheet resulting from the
strategic restructuring of the Company during fiscal 2005.
Profitability, cash flow, asset sale proceeds and timing can be impacted by
certain external factors such as unfavorable economic conditions, competition,
labor relations and fuel and utility costs which could have a significant impact
on cash generation. If our profitability and cash flow do not improve in line
with our plans or if the taxing authorities do not affirm the adequacy of our
Company's Domestic Reinvestment Plan, we anticipate that we would be able to
liquidate our investment in Metro, Inc. and or modify the operating plan in
order to ensure that we have appropriate resources.
WORKING CAPITAL
We had working capital of $295.7 million at June 17, 2006 compared to working
capital of $599.7 million at February 25, 2006. We had cash and cash equivalents
aggregating $97.0 million at June 17, 2006 compared to $229.6 million at
February 25, 2006. The decrease in working capital was attributable primarily to
the following:
o A decrease in cash and cash equivalents as detailed in the Consolidated
Statements of Cash Flows;
o A decrease in restricted cash and marketable securities due to the payment
of a one-time special dividend as discussed in Note 3 - Special One-Time
Dividend;
o A decrease in accounts receivable due to the timing and collection of
receipts; and
o An increase in the current portion of our long-term debt primarily due to
our 7.75% Notes becoming due on April 15, 2007.
Partially offset by the following:
o A decrease in accrued salaries, wages and benefits due to timing of
payments; and
o A decrease in other accruals due to timing.
43
REVOLVING CREDIT AGREEMENT
During fiscal 2005, we entered into a new, cash collateralized, Letter of Credit
Agreement that enables us to issue letters of credit up to $200 million. We also
secured a $150 million Revolver with four lenders enabling us to borrow funds on
a revolving basis for working capital loans and letters of credit. The Revolver
includes a $100 million accordion feature which gives us the ability to increase
commitments from $150 million to $250 million. Effective April 4, 2006, we
exercised the accordion option and increased our commitments to $250 million.
Under the terms of this agreement, should availability fall below $25.0 million
and should cash on hand fall below $50.0 million, a borrowing block will be
implemented which provides that no additional loans be made unless we are able
to maintain a minimum consolidated EBITDA covenant on a trailing twelve month
basis. In the event that availability falls below $25.0 million, cash on hand
falls below $50.0 million, and we do not maintain the required minimum EBITDA
covenant, unless otherwise waived or amended, the lenders may, at their
discretion, declare, in whole or in part, all outstanding obligations
immediately due and payable.
The Revolver is collateralized by inventory, certain accounts receivable and
pharmacy scripts. Borrowings under the Revolver bear interest based on LIBOR or
Prime interest rate pricing. This agreement expires in November 2010. At June
17, 2006, there were no letters of credit outstanding under this agreement;
however, there were $70.5 million in outstanding borrowings under the Revolver.
As of June 17, 2006, after reducing availability for borrowing base
requirements, we had $176.2 million available under the Revolver. Combined with
cash we held in short-term investments and marketable securities of $103.4
million, we had total cash availability of $279.6 million at June 17, 2006.
Under the Revolver, we are permitted to pay cumulative cash dividends on common
shares as well as make bond repurchases which we may do from time to time in the
future.
PUBLIC DEBT OBLIGATIONS
Outstanding notes totaling $244.7 million at June 17, 2006 consisted of $31.9
million of 7.75% Notes due April 15, 2007, $12.8 million of 9.125% Senior Notes
due December 15, 2011 and $200 million of 9.375% Notes due August 1, 2039.
Interest is payable quarterly on the 9.375% Notes and semi-annually on the
9.125% and 7.75% Notes. The 7.75% Notes are not redeemable prior to their
maturity. The 9.375% notes are now callable at par ($25 per bond) and the 9.125%
Notes may be called at a premium to par after December 15, 2006. The 9.375%
Notes are unsecured obligations and were issued under the terms of our senior
debt securities indenture, which contains among other provisions, covenants
restricting the incurrence of secured debt. The 9.375% Notes are effectively
subordinate to the Revolver and do not contain cross default provisions. All
covenants and restrictions for the 7.75% Notes and the 9.125% Senior Notes have
been eliminated in connection with the cash tender offer in fiscal 2005. Our
notes are not guaranteed by any of our subsidiaries.
During the first quarter of fiscal 2005, we repurchased in the open market $14.5
million of our 7.75% Notes due April 15, 2007. The cost of this open market
repurchase resulted in a pretax loss due to the early extinguishment of debt of
$0.5 million. In accordance with SFAS No. 145, "Rescission of FASB Statements 4,
44 and 64, Amendment of FASB 13, and Technical Corrections" ("SFAS 145"), this
loss has been classified within loss from operations. There were no similar
repurchases in the first quarter of fiscal 2006.
44
OTHER
We currently have active Registration Statements dated January 23, 1998 and June
23, 1999, allowing us to offer up to $75 million of debt and/or equity
securities at terms contingent upon market conditions at the time of sale.
Although our Company paid a special one-time dividend to our shareholders of
record on April 17, 2006 equal to $7.25 per share, our Company's practice is to
not pay dividends. As such, we have not made dividend payments in the previous
three years and do not intend to pay dividends in the normal course of business
in fiscal 2006. However, our Company is permitted under the terms of our
Revolver, to pay cash dividends on common shares.
We are the guarantor of a loan of $1.7 million related to a shopping center,
which will expire in 2011.
In the normal course of business, we have assigned to third parties various
leases related to former operating stores (the "Assigned Leases"). At the time
the leases were assigned, we generally remained secondarily liable with respect
to these lease obligations. As such, if any of the assignees were to become
unable to continue making payments under the Assigned Leases, we could be
required to assume the lease obligation. As of June 17, 2006, 122 Assigned
Leases remain in place. Assuming that each respective assignee became unable to
continue to make payments under an Assigned Lease, an event we believe to be
remote, we estimate our maximum potential obligation with respect to the
Assigned Leases to be approximately $310.4 million, which could be partially or
totally offset by reassigning or subletting such leases.
Our existing senior debt rating was Caa1 with negative outlook with Moody's
Investors Service ("Moody's") and B- with stable outlook with Standard & Poor's
Ratings Group ("S&P") as of June 17, 2006. Our liquidity rating was SGL3 with
Moody's as of June 17, 2006. Our recovery rating was 1 with S&P as of June 17,
2006 indicating a high expectation of 100% recovery of our senior debt to our
lenders. Future rating changes could affect the availability and cost of
financing to our Company.
CRITICAL ACCOUNTING ESTIMATES
Critical accounting estimates are those accounting estimates that we believe are
important to the portrayal of our financial condition and results of operations
and require our most difficult, subjective or complex judgments, often as a
result of the need to make estimates about the effect of matters that are
inherently uncertain.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America ("U.S. GAAP") requires us to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Self-Insurance Reserves
Our Consolidated Balance Sheets include liabilities with respect to self-insured
workers' compensation and general liability claims. We estimate the required
liability of such claims on a discounted basis, utilizing an actuarial method,
which is based upon various assumptions, which include, but are not limited to,
our historical loss experience, projected loss development factors, actual
payroll and other data. The required liability is also subject to adjustment in
the future based upon the changes in claims experience,
45
including changes in the number of incidents (frequency) and changes in the
ultimate cost per incident (severity).
Long-Lived Assets
We review the carrying values of our long-lived assets for possible impairment
whenever events or changes in circumstances indicate that the carrying amount of
assets may not be recoverable. Such review is based upon groups of assets and
the undiscounted estimated future cash flows from such assets to determine if
the carrying value of such assets is recoverable from their respective cash
flows. If such review indicates an impairment exists, we measure such impairment
on a discounted basis using a probability weighted approach and a 7 year U.S.
Treasury risk free rate.
We also review assets in stores planned for closure or conversion for impairment
upon determination that such assets will not be used for their intended useful
life. During the 16 weeks ended June 17, 2006, we recorded U.S. impairment
losses on long-lived assets as follows:
Impairments due to closure or conversion in the
normal course of business $1.2
Impairments related to our asset disposition initiatives (1) 1.1
----
Total impairments $2.3
====
(1) Refer to Note 8 - Asset Disposition Initiatives
All of these amounts are included in SG&A in our Consolidated Statements of
Operations. The effects of changes in estimates of useful lives were not
material to ongoing depreciation expense.
If current operating levels do not continue to improve, there may be future
impairments on long-lived assets, including the potential for impairment of
assets that are held and used.
Closed Store and Closed Warehouse Reserves
For closed stores and warehouses that are under long-term leases, we record a
discounted liability using a risk free rate for the future minimum lease
payments and related costs, such as utilities and taxes, from the date of
closure to the end of the remaining lease term, net of estimated probable
recoveries from projected sublease rentals. If estimated cost recoveries exceed
our liability for future minimum lease payments, the excess is recognized as
income over the term of the sublease. We estimate future net cash flows based on
our experience in and our knowledge of the market in which the closed store and
warehouse is located. However, these estimates project net cash flow several
years into the future and are affected by variable factors such as inflation,
real estate markets and economic conditions. While these factors have been
relatively stable in recent years, variation in these factors could cause
changes to our estimates. As of June 17, 2006, we had recorded liabilities for
estimated probable obligations of $187 million. Of this amount, $24 million
relates to stores closed in the normal course of business, $153 million relates
to stores and warehouses closed as part of the asset disposition initiatives
(see Note 8 of our Consolidated Financial Statements), and $10 million relates
to stores closed as part of our exit of the northern New England and Kohl's
businesses (see Note 7 of our Consolidated Financial Statements).
Employee Benefit Plans
The determination of our obligation and expense for pension and other
postretirement benefits is dependent, in part, on our selection of certain
assumptions used by our actuaries in calculating these amounts. These
assumptions include, among other things, the discount rate, the expected
long-term rate of return on plan
46
assets and the rates of increase in compensation and health care costs. In
accordance with U.S. GAAP, actual results that differ from our Company's
assumptions are accumulated and amortized over future periods and, therefore,
affect our recognized expense and recorded obligation in such future periods.
While we believe that our assumptions are appropriate, significant differences
in our actual experience or significant changes in our assumptions may
materially affect our pension and other post-retirement obligations and our
future expense.
Inventories
We evaluate inventory shrinkage throughout the year based on actual physical
counts and record reserves based on the results of these counts to provide for
estimated shrinkage between the store's last inventory and the balance sheet
date.
Income Taxes
As discussed in Note 11 of the Consolidated Financial Statements, our Company
recorded a valuation allowance for the entire U.S. net deferred tax asset since,
in accordance with SFAS 109, it was more likely than not that the net deferred
tax asset would not be utilized based on historical cumulative losses. Under
SFAS 109, this valuation allowance could be reversed in future periods if our
Company experiences improvement in our U.S. operations.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standard Board ("FASB") issued SFAS
151, "Inventory Costs, an Amendment of ARB No. 43, Chapter 4" ("SFAS 151"). SFAS
151 requires that handling costs and waste material (spoilage) be recognized as
current-period charges regardless of whether they meet the previous requirement
of being abnormal. In addition, this Statement requires that allocations of
fixed overhead to the cost of inventory be based on the normal capacity of the
production facilities. SFAS 151 is effective for our 2006 fiscal year. We have
evaluated the provisions of SFAS 151 and concluded that its adoption did not
have a material impact on our consolidated financial position or results of
operations.
In December 2004, the FASB issued SFAS 153, "Exchanges of Nonmonetary Assets, an
Amendment of APB Opinion No. 29" ("SFAS 153"). SFAS 153 is based on the
principle that exchanges of nonmonetary assets should be measured based on the
fair value of the assets exchanged. This pronouncement amends APB No. 29 to
eliminate the exception for nonmonetary exchanges of similar productive assets
and replaces it with a general exception for exchanges of nonmonetary assets
that do not have commercial substance. A nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. SFAS 153 is effective for nonmonetary
exchanges occurring in fiscal periods beginning after June 15, 2005 (the quarter
ended June 17, 2006 for our Company). We have evaluated the provisions of SFAS
153 and concluded that its adoption did not have a material impact on our
consolidated financial position or results of operations.
In May 2005, the FASB issued SFAS 154, "Accounting Changes and Error
Corrections" ("SFAS 154") which replaces Accounting Principles Board Opinions
No. 20 "Accounting Changes" and SFAS No. 3, "Reporting Accounting Changes in
Interim Financial Statements-An Amendment of APB Opinion No. 28." SFAS 154
provides guidance on the accounting for and reporting of accounting changes and
error corrections. It establishes retrospective application, unless
impracticable, as the required method for reporting a change in accounting
principle and the reporting of a correction of an error. FAS 154 is effective
for accounting changes and corrections of errors made in fiscal years beginning
after December
47
15, 2005. We have evaluated the provisions of SFAS 154 and have
concluded that we have not had an accounting change or error correction that
would require retrospective application in the first quarter of fiscal 2006.
In September 2005, the FASB ratified the consensus reached in EITF Issue No.
04-13, "Accounting for Purchases and Sales of Inventory with the Same
Counterparty" (EITF 04-13). EITF 04-13 defines when a purchase and a sale of
inventory with the same party that operates in the same line of business should
be considered a single nonmonetary transaction. EITF 04-13 is effective for new
arrangements that a company enters into in periods beginning after March 15,
2006 (our second quarter beginning June 18, 2006). We have evaluated the
provisions of EITF 04-13 and have adopted the guidance. This adoption did not
have a material impact on our Company's financial position or results of
operations.
In October 2005, the FASB issued FASB Staff Position FAS 13-1 ("FSP FAS 13-1"),
which requires companies to expense rental costs associated with ground or
building operating leases that are incurred during a construction period. As a
result, companies that are currently capitalizing these rental costs are
required to expense them beginning in its first reporting period beginning after
December 15, 2005. FSP FAS 13-1 is effective for our Company as of the first
quarter of fiscal 2006. We evaluated the provisions of FSP FAS 13-1 and have
adopted the guidance. This adoption did not have a material impact on our
Company's financial position or results of operations.
On November 3, 2005, the FASB issued FASB Staff Position FAS 115-1 and FAS
124-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments" (FSP FAS 115-1 and FAS 124-1"). FSP FAS 115-1 and FAS 124-1
address the determination as to when an investment is considered impaired,
whether that impairment is other-than-temporary and the measurement of loss. It
also includes accounting considerations subsequent to the recognition of an
other-than-temporary impairment and requires certain disclosures about
unrealized losses that have not been recognized as other-than-temporary
impairments. FSP FAS 115-1 and FAS 124-1 are effective for reporting periods
beginning after December 15, 2005 and are required to be adopted by our Company
in the first quarter of fiscal 2006. We have adopted the guidance and included
the necessary disclosures relating to unrealized losses that have not been
recognized as other-than-temporary impairments in Note 5 - Cash, Restricted
Cash, Cash Equivalents and Marketable Securities at June 17, 2006.
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes--an Interpretation of FASB Statement 109 ("FIN 48"),
which clarifies the accounting for uncertainty in tax positions. This
Interpretation provides that the tax effects from an uncertain tax position can
be recognized in our financial statements, only if the position is more likely
than not of being sustained on audit, based on the technical merits of the
position. The provisions of FIN 48 are effective as of the beginning of fiscal
2007, with the cumulative effect of the change in accounting principle recorded
as an adjustment to opening retained earnings. We are currently evaluating the
impact of adopting FIN 48 on our financial statements.
48
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
Market risk represents the risk of loss from adverse market changes that may
impact our consolidated financial position, results of operations or cash flows.
Among other possible market risks, we are exposed to such risk in the areas of
interest rates and foreign currency exchange rates.
From time to time, we may enter hedging agreements in order to manage risks
incurred in the normal course of business including forward exchange contracts
to manage our exposure to fluctuations in foreign exchange rates.
INTEREST RATES
Our exposure to market risk for changes in interest rates relates primarily to
our debt obligations. We do not have cash flow exposure due to rate changes on
our $317.2 million in total indebtedness as of June 17, 2006 because they are at
fixed interest rates. However, we do have cash flow exposure on our committed
bank lines of credit due to our variable floating rate pricing. Accordingly,
during the first quarters of fiscal 2006 and fiscal 2005, a presumed 1% change
in the variable floating rate would have impacted interest expense by $0.1
million and nil, respectively.
FOREIGN EXCHANGE RISK
We are exposed to foreign exchange risk to the extent of adverse fluctuations in
the Canadian dollar. A change in the Canadian currency of 10% would have
resulted in a fluctuation in our investment in Metro, Inc. of $35.7 million at
June 17, 2006. During the first quarter of fiscal 2005, a change in the Canadian
currency of 10% would have resulted in a fluctuation in net loss of $2.0
million.
In addition, during the first quarter of fiscal 2005, we entered into a six
month currency exchange forward contract totaling $900 million Canadian dollar
notional value to hedge our net investment in our Canadian foreign operation
against adverse movements in exchange rates. A 100 basis point strengthening in
the foreign currency forward rate would decrease the fair market value of our
foreign currency forward contract held at June 18, 2005, by $7.3 million. A 100
basis point weakening in the foreign currency forward rate would increase the
fair market value of our foreign currency forward contract held at June 18,
2005, by $7.1 million.
ITEM 4 - CONTROLS AND PROCEDURES
We have established and maintain disclosure controls and procedures that are
designed to ensure that information required to be disclosed in our Company's
Exchange Act reports is recorded, processed, summarized and reported within the
time periods specified in the SEC's rules and forms, and that such information
is accumulated and communicated to our Company's management, including our
President and Chief Executive Officer and Senior Vice President, Chief Financial
Officer, as appropriate, to allow timely decisions regarding required
disclosure.
We carried out an evaluation, under the supervision and with the participation
of our Company's management, including our Company's President and Chief
Executive Officer along with our Company's Senior Vice President, Chief
Financial Officer, of the effectiveness of the design and operation of our
Company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-15(b). Based upon the
49
foregoing, as of June 17, 2006, our Company's
President and Chief Executive Officer along with our Company's Senior Vice
President, Chief Financial Officer, concluded that our Company's disclosure
controls and procedures were effective as of June 17, 2006.
There have been no changes during our Company's fiscal quarter ended June 17,
2006 in our Company's internal control over financial reporting that has
materially affected, or is reasonably likely to materially affect, our Company's
internal control over financial reporting.
CAUTIONARY NOTE
This presentation may contain forward-looking statements about the future
performance of our Company, and is based on our assumptions and beliefs in light
of information currently available. We assume no obligation to update this
information. These forward-looking statements are subject to uncertainties and
other factors that could cause actual results to differ materially from such
statements including but not limited to: competitive practices and pricing in
the food industry generally and particularly in our principal markets; our
relationships with our employees; the terms of future collective bargaining
agreements; the costs and other effects of lawsuits and administrative
proceedings; the nature and extent of continued consolidation in the food
industry; changes in the financial markets which may affect our cost of capital
or the ability to access capital; supply or quality control problems with our
vendors; and changes in economic conditions, which may affect the buying
patterns of our customers.
50
PART II. OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
None
ITEM 2 - CHANGES IN SECURITIES
None
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5 - OTHER INFORMATION
None
ITEM 6 - EXHIBITS
(a) Exhibits required by Item 601 of Regulation S-K
EXHIBIT NO. DESCRIPTION
----------- -----------
2.1 Stock Purchase Agreement, dated as of July 19, 2005, by and among
the Company, A&P Luxembourg S.a.r.l., Metro Inc. and 4296711
Canada Inc. (incorporated herein by reference to Exhibit 2.1 to
Form 8-K filed on July 22, 2005)
3.1 Articles of Incorporation of The Great Atlantic & Pacific Tea
Company, Inc., as amended through July 1987 (incorporated herein
by reference to Exhibit 3(a) to Form 10-K filed on May 27, 1988)
3.2 By-Laws of The Great Atlantic & Pacific Tea Company, Inc., as
amended and restated through October 6, 2005 (incorporated herein
by reference to Exhibit 3.1 to Form 8-K filed on October 11, 2005)
51
4.1 Indenture, dated as of January 1, 1991 between the Company and
JPMorgan Chase Bank (formerly The Chase Manhattan Bank as
successor by merger to Manufacturers Hanover Trust Company), as
trustee (the "Indenture") (incorporated herein by reference to
Exhibit 4.1 to Form 8-K)
4.2 First Supplemental Indenture, dated as of December 4, 2001, to the
Indenture, dated as of January 1, 1991 between our Company and
JPMorgan Chase Bank, relating to the 7.70% Senior Notes due 2004
(incorporated herein by reference to Exhibit 4.1 to Form 8-K filed
on December 4, 2001)
4.3 Second Supplemental Indenture, dated as of December 20, 2001, to
the Indenture between our Company and JPMorgan Chase Bank,
relating to the 9 1/8% Senior Notes due 2011 (incorporated
herein by reference to Exhibit 4.1 to Form 8-K filed on December
20, 2001)
4.4 Successor Bond Trustee (incorporated herein by reference to
Exhibit 4.4 to Form 10-K filed on May 9, 2003)
4.5 Third Supplemental Indenture, dated as of August 23, 2005, to the
Indenture between the Company and Wilmington Trust Company (as
successor to JPMorgan Chase Bank) (incorporated herein by
reference to Exhibit 4.1 to Form 8-K filed on August 23, 2005)
4.6 Fourth Supplemental Indenture, dated as of August 23, 2005, to the
Indenture between the Company and Wilmington Trust Company (as
successor to JPMorgan Chase Bank). (incorporated herein by
reference to Exhibit 4.2 to Form 8-K filed on August 23, 2005)
4.7 Credit Agreement dated as of November 15, 2005 between the Company
and Bank of America, N.A. as Administrative Agent and Collateral
Agent, JPMorgan Chase Bank, N.A. as Syndication Agent, Wachovia
Bank, National Association as Documentation Agent and Banc of
America Securities LLC as Lead Arranger (incorporated herein by
reference to Exhibit 4.1 to Form 8-K filed on November 18, 2005
and Item 8.01 to Form 8-K filed April 10, 2006)
10.1 Executive Employment Agreement, made and entered into as of the
15th day of August, 2005, by and between the Company and Mr. Eric
Claus (incorporated herein by reference to Exhibit 10.1 to Form
8-K filed on September 9, 2005) and a technical amendment
(incorporated herein by reference to Exhibit 10.1 to Form 10-K
filed on May 9, 2006)
10.2 Employment Agreement, made and entered into as of the 1st day of
November, 2000, by and between the Company and William P.
Costantini (incorporated herein by reference to Exhibit 10 to Form
10-Q filed on January 16, 2001) ("Costantini Agreement")
52
10.3 Amendment to Costantini Agreement dated April 30, 2002
(incorporated herein by reference to Exhibit 10.7 to Form 10-K
filed on July 5, 2002)
10.4 Confidential Separation and Release Agreement by and between
William P. Costantini and The Great Atlantic & Pacific Tea
Company, Inc. dated November 4, 2004 (incorporated herein by
reference to Exhibit 10.4 to Form 10-Q filed on January 7, 2005)
10.5 Employment Agreement, made and entered into as of the 16th day of
June, 2003, by and between our Company and Brenda Galgano
(incorporated herein by reference to Exhibit 10.9 to Form 10-Q
filed on October 17, 2003)
10.6 Employment Agreement, made and entered into as of the 24th day of
February, 2002, by and between our Company and Mitchell P.
Goldstein (incorporated herein by reference to Exhibit 10.8 to
Form 10-K filed on July 5, 2002)
10.7 Letter Agreement dated September 6, 2005, between Mitchell P.
Goldstein and our Company (incorporated herein by reference to
Exhibit 10.2 to Form 8-K filed on September 9, 2005)
10.8 Employment Agreement, made and entered into as of the 2nd day of
October, 2002, by and between our Company and Peter Jueptner
(incorporated herein by reference to Exhibit 10.26 to Form 10-Q
filed on October 22, 2002) ("Jueptner Agreement")
10.9 Amendment to Jueptner Agreement dated November 10, 2004
(incorporated herein by reference to Exhibit 10.8 to Form 10-K
filed on May 10, 2005)
10.10 Offer Letter dated the 18th day of September 2002, by and between
our Company and Peter Jueptner (incorporated herein by reference
to Exhibit 10.10 to Form 10-Q filed on January 10, 2003)
10.11 Employment Agreement, made and entered into as of the 14th day of
May, 2001, by and between our Company and John E. Metzger, as
amended February 14, 2002 (incorporated herein by reference to
Exhibit 10.13 to Form 10-K filed on July 5, 2002) ("Metzger
Agreement")
10.12 Amendment to John E. Metzger Agreement dated October 25, 2004
(incorporated herein by reference to Exhibit 10.12 to Form 10-K
filed on May 10, 2005)
10.13 Employment Agreement, made and entered into as of the 25th day of
January, 2006, by and between our Company and Jennifer MacLeod
(incorporated herein by reference to Exhibit 10.13 to Form 10-K
filed on May 9, 2006)
53
10.14 Employment Agreement, made and entered into as of the 1st day of
March 2005, by and between our Company and William J. Moss
(incorporated herein by reference to Exhibit 10.13 to Form 10-K
filed on May 10, 2005)
10.15 Employment Agreement, made and entered into as of the 28th day of
October, 2002, by and between our Company and Brian Piwek, and
Offer Letter dated the 23rd day of October, 2002 (incorporated
herein by reference to Exhibit 10.14 to Form 10-Q filed on January
10, 2003) ("Piwek Agreement")
10.16 Amendment to Brian Piwek Agreement dated February 4, 2005
(incorporated herein by reference to Exhibit 10.15 to Form 10-K
filed on May 10, 2005)
10.17 Employment Agreement, made and entered into as of the 4th of
January 2006, by and between our Company and Melissa E. Sungela
(incorporated herein by reference to Exhibit 10.17 to Form 10-Q
filed on January 6, 2006)
10.18 Employment Agreement, made and entered into as of the 12th of
September 2005, by and between our Company and Paul Wiseman
(incorporated herein by reference to Exhibit 10.17 to Form 10-Q
filed on October 18, 2005)
10.19 Employment Agreement, made and entered into as of the 2nd of
December 2004, by and between our Company and Allan Richards
(incorporated herein by reference to Exhibit 10.18 to Form 10-Q
filed on October 18, 2005)
10.20 Employment Agreement, made and entered into as of the 2nd of
December 2004, by and between our Company and Stephen Slade
(incorporated herein by reference to Exhibit 10.19 to Form 10-Q
filed on October 18, 2005)
10.21 Supplemental Executive Retirement Plan effective as of September
1, 1997 (incorporated herein by reference to Exhibit 10.B to Form
10-K filed on May 27, 1998)
10.22 Supplemental Retirement and Benefit Restoration Plan effective as
of January 1, 2001 (incorporated herein by reference to Exhibit
10(j) to Form 10-K filed on May 23, 2001)
10.23 1994 Stock Option Plan (incorporated herein by reference to
Exhibit 10(e) to Form 10-K filed on May 24, 1995)
10.24 1998 Long Term Incentive and Share Award Plan (incorporated herein
by reference to Exhibit 10(k) to Form 10-K filed on May 19, 1999,
to Appendix B to the Proxy Statement dated May 27, 2005 and to
Appendix B to the Proxy Statement dated May 25, 2006)
10.25 Form of Stock Option Grant (incorporated herein by reference to
Exhibit 10.20 to Form 10-K filed on May 10, 2005)
54
10.26 Description of 2005 Turnaround Incentive Compensation Program
(incorporated herein by reference to Exhibit 10.21 to Form 10-K
filed on May 10, 2005)
10.27 Form of Restricted Share Unit Award Agreement (incorporated herein
by reference to Exhibit 10.22 to Form 10-K filed on May 10, 2005)
10.28* Description of 2006 Long Term Incentive Plan, as filed herein
10.29* Form of 2006 Restricted Share Unit Award Agreement, as filed
herein
10.30 1994 Stock Option Plan for Non-Employee Directors (incorporated
herein by reference to Exhibit 10(f) to Form 10-K filed on May 24,
1995)
10.31 2004 Non-Employee Director Compensation effective as of July 14,
2004 (incorporated herein by reference to Exhibit 10.15 to Form
10-Q filed on July 29, 2004 and to Appendix C to the Proxy
Statement dated May 25, 2006)
10.32 Description of Management Incentive Plan (incorporated herein by
reference to Exhibit 10.30 to Form 10-K filed on May 9, 2006)
10.33 Asset Purchase Agreement, dated as of June 27, 2005, by and
between the Company, Ocean Logistics LLC and C&S Wholesale
Grocers, Inc. (incorporated herein by reference to Exhibit 10.38
to Form 10-Q filed on October 18, 2005)
10.34 Supply Agreement, dated as of June 27, 2005, by and between the
Company and C&S Wholesale Grocers, Inc. (incorporated herein by
reference to Exhibit 10.39 to Form 10-Q filed on October 18, 2005)
10.35 Information Technology Transition Services Agreement by and
between The Great Atlantic and Pacific Tea Company, Limited ("A&P
Canada") and Metro, Inc. entered into on August 15, 2005
(incorporated herein by reference to Exhibit 10.40 to Form 10-Q
filed on October 18, 2005)
10.36 Investor Agreement by and between A&P Luxembourg S.a.r.l., a
wholly owned subsidiary of the Company, and Metro, Inc. entered
into on August 15, 2005 (incorporated herein by reference to
Exhibit 10.41 to Form 10-Q filed on October 18, 2005)
10.37 Letter of Credit Agreement, dated as of October 14, 2005 between
the Company and Bank of America, N.A., as Issuing Bank,
(incorporated herein by reference to Exhibit 10.42 to Form 10-Q
filed on October 18, 2005)
16 Letter on Change in Certifying Accountant (incorporated herein by
reference to Forms 8-K filed on September 18, 2002 and September
24, 2002, and Form 8-K/A filed on September 24, 2002)
55
18 Preferability Letter Issued by PricewaterhouseCoopers LLP
(incorporated herein by reference to Exhibit 18 to Form 10-Q filed
on July 29, 2004)
23 Consent of Independent Registered Public Accounting Firm
(incorporated herein by reference to Exhibit 23 to Form 10-K filed
on May 9, 2006)
31.1* Certification of the Chief Executive Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
31.2* Certification of the Chief Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
32* Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
* Filed with this 10-Q
56
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
Dated: July 21, 2006 By: /s/ Melissa E. Sungela
-----------------------------------------------
Melissa E. Sungela, Vice President,
Corporate Controller (Chief Accounting Officer)
57