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 the quarterly period ended June 14, 2008
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 a large accelerated filer, an
accelerated filer, a non-accelerated filer, or smaller reporting company. See
definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [X]
Non-accelerated filer [ ] (Do not check if smaller reporting company) Smaller reporting company [ ]
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
YES [ ] NO [X]
As of July 15, 2008 the Registrant had a total of 57,641,586 shares of common
stock - $1 par value outstanding.
1
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 14, 2008 June 16, 2007
--------------- ---------------
Sales $ 2,922,665 $ 1,679,169
Cost of merchandise sold (2,039,079) (1,156,187)
--------------- ----------------
Gross margin 883,586 522,982
Store operating, general and administrative expense (881,495) (529,356)
--------------- ----------------
Income (loss) from operations 2,091 (6,374)
Loss on sale of Canadian operations - (281)
Gain on sale of Metro, Inc. - 78,388
Nonoperating income 48,597 -
Interest expense (45,949) (19,713)
Interest and dividend income 410 4,666
Equity in earnings of Metro, Inc. - 7,869
--------------- ----------------
Income from continuing operations before income taxes 5,149 64,555
Provision for income taxes (1,384) (3,149)
---------------- -----------------
Income from continuing operations 3,765 61,406
Discontinued operations:
Loss from operations of discontinued businesses, net of tax benefit of $0
for both the 16 weeks ended June 14, 2008 and the 16 weeks
ended June 16, 2007, respectively (4,163) (79,780)
Gain (loss) on disposal of discontinued operations, net of tax benefit of $0
For both the 16 weeks ended June 14, 2008 and June 16, 2007,
respectively 2,639 (46,768)
--------------- ----------------
Loss from discontinued operations (1,524) (126,548)
--------------- ----------------
Net income (loss) $ 2,241 $ (65,142)
=============== ================
Net income (loss) per share - basic:
Continuing operations $ 0.08 $ 1.47
Discontinued operations (0.03) (3.03)
--------------- -----------------
Net income (loss) per share - basic $ 0.05 $ (1.56)
=============== ================
Net (loss) income per share - diluted:
Continuing operations $ (0.48) $ 1.45
Discontinued operations (0.03) (2.99)
--------------- ----------------
Net loss per share - diluted $ (0.51) $ (1.54)
=============== ================
Weighted average number of common shares outstanding
Basic 49,786,027 41,801,381
=============== ================
Diluted 48,156,654 42,259,837
=============== ================
See Notes to Quarterly Report
2
The Great Atlantic & Pacific Tea Company, Inc.
Consolidated Statements of Stockholders' Equity and Comprehensive (Loss) Income
(Dollars in thousands)
(Unaudited)
Common Stock Additional
--------------------------- Paid-in Retained
Shares Amount Capital Earnings
------------ ----------- ----------- ----------
16 Week Period Ended June 14, 2008
----------------------------------
Balance at beginning of period 57,100,955 $ 57,101 $ 447,103 $ 16,423
Net income 2,241
Other comprehensive loss
Conversion features related to
convertible debt 18,241
Stock options exercised 104,536 104 2,071
Other share based awards 435,600 436 4,410
------------ ----------- ----------- ----------
Balance at end of period 57,641,091 $ 57,641 $ 471,825 $ 18,664
============ =========== =========== ==========
16 Week Period Ended June 16, 2007
----------------------------------
Balance at February 24, 2007,
as previously reported 41,589,195 $ 41,589 $ 212,868 $ 153,325
Impact of the adoption of change
in measurement date under
FAS 158 (643)
Cumulative impact of
the adoption of FIN 48 24,421
------------ ----------- ----------- ----------
Balance at beginning of period,
as adjusted 41,589,195 41,589 212,868 177,103
Net loss (65,142)
Other comprehensive income
Stock options exercised 324,431 325 5,299
Tax benefit on stock options 1,701
Other share based awards 2,821
------------ ----------- ----------- ----------
Balance at end of period 41,913,626 $ 41,914 $ 222,689 $ 111,961
============ =========== =========== ==========
Accumulated Other Total
Comprehensive Call Stockholders'
(Loss) Income Options Equity
----------------- --------- ---------------
16 Week Period Ended June 14, 2008
----------------------------------
Balance at beginning of period $ (28,975) $ (73,509) $ 418,143
Net income 2,241
Other comprehensive loss (340) (340)
Conversion features related to
convertible debt 18,241
Stock options exercised 2,175
Other share based awards 4,846
----------------- --------- ---------------
Balance at end of period $ (29,315) $ (73,509) $ 445,306
================= ========= ===============
16 Week Period Ended June 16, 2007
----------------------------------
Balance at February 24, 2007,
as previously reported $ 22,888 $ - $ 430,670
Impact of the adoption of change
n measurement date under
FAS 158 (643)
Cumulative impact of
the adoption of FIN 48 24,421
----------------- --------- ---------------
Balance at beginning of period,
as adjusted 22,888 - 454,448
Net loss (65,142)
Other comprehensive income 137,408 137,408
Stock options exercised 5,624
Tax benefit on stock options 1,701
Other share based awards 2,821
----------------- --------- ---------------
Balance at end of period $ 160,296 $ - $ 536,860
================= ========= ===============
See Notes to Quarterly Report
3
The Great Atlantic & Pacific Tea Company, Inc.
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss)
(Dollars in thousands)
(Unaudited)
Comprehensive Income (Loss)
---------------------------
16 Weeks Ended
-----------------------------------
June 14, 2008 June 16, 2007
------------- -------------
Net income (loss) $ 2,241 $ (65,142)
--------- -----------
Foreign currency translation adjustment - 16,045
Net unrealized gain on investment securities, net of tax - 121,740
Net unrealized gain on marketable securities, net of tax - 22
Pension and other post-retirement benefits, net of tax (340) (399)
--------- -----------
Other comprehensive (loss) income, net of tax (340) 137,408
--------- -----------
Total comprehensive income $ 1,901 $ 72,266
========= ===========
Accumulated Other Comprehensive (Loss) Income Balances
------------------------------------------------------
Net Net Pension
Unrealized Unrealized & Other Accumulated
Foreign Gain on (Loss) Income Post- Other
Currency Investment on Marketable retirement Comprehensive
Translation Securities Securities Benefits (Loss) Income
------------- ------------- ------------- ---------------- --------------
Balance at February 23, 2008 $ - $ - $ - $ (28,975) $ (28,975)
Current period change - - - (340) (340)
----------- --------- ----------- ----------- -----------
Balance at June 14, 2008 $ - $ - $ - $ (29,315) $ (29,315)
=========== ========= =========== =========== ===========
Balance at February 24, 2007 $ 9,710 $ - $ (22) $ 13,200 $ 22,888
Current period change 16,045 121,740 22 (399) 137,408
----------- --------- ----------- ----------- -----------
Balance at June 16, 2007 $ 25,755 $ 121,740 $ - $ 12,801 $ 160,296
=========== ========= =========== =========== ===========
See Notes to Quarterly Report
4
The Great Atlantic & Pacific Tea Company, Inc.
Consolidated Balance Sheets
(Dollars in thousands except share amounts)
June 14, 2008 February 23, 2008
------------- -----------------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 129,053 $ 100,733
Restricted cash 3,781 3,713
Restricted marketable securities 7,119 6,796
Accounts receivable, net of allowance for doubtful accounts of
$9,693 and $6,152 at June 14, 2008 and February 23, 2008,
respectively 176,594 173,203
Inventories 522,632 505,012
Prepaid expenses and other current assets 98,630 94,969
------------- --------------
Total current assets 937,809 884,426
------------- --------------
Non-current assets:
Property:
Property owned, net 1,718,131 1,751,440
Property leased under capital leases, net 143,693 149,363
------------- --------------
Property, net 1,861,824 1,900,803
Goodwill 447,682 387,546
Intangible assets, net 231,240 234,086
Other assets 249,348 241,057
------------- --------------
Total assets $ 3,727,903 $ 3,647,918
============= ==============
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 17,473 $ 11,875
Current portion of obligations under capital leases 11,608 11,344
Current portion of other financial liabilities - 44,539
Accounts payable 268,934 216,703
Book overdrafts 53,640 36,435
Accrued salaries, wages and benefits 139,519 169,552
Accrued taxes 48,619 46,156
Other accruals 248,951 230,733
------------- --------------
Total current liabilities 788,744 767,337
------------- --------------
Non-current liabilities:
Long-term debt 843,594 758,886
Long-term obligations under capital leases 154,254 157,430
Long-term real estate liabilities 346,128 346,110
Deferred real estate income 79,669 81,110
Other financial liabilities 112,216 180,250
Other non-current liabilities 957,992 938,652
------------- --------------
Total liabilities 3,282,597 3,229,775
------------- --------------
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 - 57,641,091 and 57,100,955 shares
at June 14, 2008 and February 23, 2008, respectively 57,641 57,101
Call options (73,509) (73,509)
Additional paid-in capital 471,825 447,103
Accumulated other comprehensive loss (29,315) (28,975)
Retained earnings 18,664 16,423
------------- --------------
Total stockholders' equity 445,306 418,143
------------- --------------
Total liabilities and stockholders' equity $ 3,727,903 $ 3,647,918
============= ==============
See Notes to Quarterly Report
5
The Great Atlantic & Pacific Tea Company, Inc.
Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
16 Weeks Ended
-------------------------------------
June 14, 2008 June 16, 2007
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 2,241 $ (65,142)
Adjustments to reconcile net income (loss) to net cash (used in)
provided by operating activities:
Asset disposition initiatives (1,785) 152
Depreciation and amortization 80,027 56,349
(Gain) loss on disposal of owned property and write-down of property, net (532) 1,161
(Gain) loss on disposal of discontinued operations (2,639) 46,768
Other property impairments 781 451
Loss on sale of Canadian operations - 281
Nonoperating income (48,597) -
Other share based awards 4,846 2,821
Equity in earnings of Metro, Inc. - (7,869)
Gain on sale of shares of Metro, Inc. - (78,388)
Other changes in assets and liabilities:
(Increase) decrease in receivables (3,246) 27,880
(Increase) decrease in inventories (16,531) 29,009
Increase in prepaid expenses and other current assets (14,654) (7,244)
Increase in other assets (6,423) (8,415)
Increase (decrease) in accounts payable 46,993 (11,933)
(Decrease) increase in accrued salaries, wages and benefits, and taxes (27,595) 7,262
Increase (decrease) in other accruals 13,612 (6,842)
(Decrease) increase in other non-current liabilities (35,925) 40,734
Other operating activities, net 4,012 596
----------- ------------
Net cash (used in) provided by operating activities (5,415) 27,631
----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for property (29,690) (50,916)
Proceeds from disposal of property 3,131 3,070
Disposal related expenditures for sale of Canadian operations - (281)
Increase in restricted cash (68) (142,911)
Proceeds from the sale of shares of Metro, Inc. - 203,492
Proceeds from maturities of marketable securities 957 20,446
----------- ------------
Net cash (used in) provided by investing activities (25,670) 32,900
----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds under revolving lines of credit 497,361 295,100
Principal payments on revolving lines of credit (416,261) (325,100)
Proceeds under line of credit 54,457 -
Principal payments on line of credit (48,951) (31,933)
Settlement of Series A warrants (45,735) -
Long-term real estate liabilities - 2,165
Principal payments on capital leases (2,393) (1,549)
Increase in book overdrafts 17,205 1,498
Deferred financing fees 1,551 (36)
Tax benefit on stock options - 1,701
Proceeds from stock options exercised 2,175 5,624
----------- ------------
Net cash provided by (used in) financing activities 59,409 (52,530)
Effect of exchange rate changes on cash and cash equivalents (4) 7
----------- ------------
Net increase in cash and cash equivalents 28,320 8,008
Cash and cash equivalents at beginning of period 100,733 86,194
----------- ------------
Cash and cash equivalents at end of period $ 129,053 $ 94,202
=========== ============
SUPPLEMENTAL DISCOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for interest $ 31,281 $ 19,858
=========== ============
Cash paid during the year for income taxes $ 1,494 $ 1,608
=========== ============
See Notes to Quarterly Report
6
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 for the 16 weeks ended
June 14, 2008 and June 16, 2007, Consolidated Statements of Stockholders' Equity
and Comprehensive (Loss) Income, and Consolidated Statements of Cash Flows for
the 16 weeks ended June 14, 2008 and June 16, 2007, and the Consolidated Balance
Sheets at June 14, 2008 and February 23, 2008 of The Great Atlantic & Pacific
Tea Company, Inc. ("We," "Our," "Us" 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 2007 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 subsidiaries. All intercompany accounts and transactions have been
eliminated.
As discussed in Note 8 - Discontinued Operations, the criteria necessary to
classify the operations for the Midwest and the Greater New Orleans area as
discontinued were satisfied in fiscal 2007 and as such, have been reclassified
in our Consolidated Statements of Operations for the 16 weeks ended June 14,
2008 and June 16, 2007.
Certain reclassifications have been made to prior year amounts to conform to
current year presentation.
2. Impact of New Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring
fair value in accordance with generally accepted accounting principles, and
expands disclosures about fair value measurements. The provisions of SFAS 157
are effective for fiscal years beginning after November 15, 2007 (our year
ending February 28, 2009). In February 2008, the FASB also issued Staff Position
No. 157-1, "Application of FASB Statement No. 157 to FASB Statement No. 13 and
Other Accounting Pronouncements that Address Fair Value Measurements for
Purposes of Lease Classification or Measurement under Statement 13" ("FSP FAS
157-1"). FSP FAS 157-1 excludes FASB Statement No. 13, "Accounting for Leases"
("SFAS 13"), as well as other accounting pronouncements that address fair value
measurements on lease classification or measurement under Statement 13, from the
scope of SFAS 157. FSP FAS 157-1 is effective upon the initial adoption of SFAS
157.
In addition, in February 2008, the FASB issued FASB Staff Position No. 157-2,
"Effective Date of FASB Statement No. 157" ("FSP FAS 157-2"). FSP FAS 157-2
delays the effective date of SFAS 157 for all nonrecurring fair value
measurements of nonfinancial assets and nonfinancial liabilities until fiscal
years beginning after November 15, 2008. FSP FAS 157-2 states that a measurement
is recurring if it happens at least annually and defines nonfinancial assets and
nonfinancial liabilities as all assets and liabilities other
7
than those meeting the definition of a financial asset or financial liability in
FASB Statement No. 159, "The Fair Value Option for Financial Assets and
Financial Liabilities." FSP FAS 157-2 is effective upon issuance. Our Company
adopted SFAS No. 157 as of February 24, 2008, with the exception of the
application of the statement to nonrecurring nonfinancial assets and
nonfinancial liabilities. Refer to Note 6 - Fair Value Measurements for further
discussion.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities--including an amendment of FASB
Statement No. 115" ("SFAS 159"). SFAS 159 permits entities to choose to measure
many financial instruments and certain other items at fair value. Unrealized
gains and losses on items for which the fair value option has been elected will
be recognized in earnings at each subsequent reporting date. The provisions of
SFAS 159 are effective for fiscal years beginning after November 15, 2007 (our
year ending February 28, 2009). The adoption of the provisions of SFAS 159 had
no effect on our Company's consolidated financial statements.
In March 2008, the FASB issued Statement of Financial Accounting Standard No.
161, "Disclosures about Derivative Instruments and Hedging Activities, an
amendment of FASB Statement No. 133" ("SFAS 161"). SFAS 161 amends and expands
the disclosure requirements of FASB Statement No. 133 with the intent to provide
users of financial statement with an enhanced understanding of (i.) how and why
an entity uses derivative instruments, (ii.) how derivative instruments and the
related hedged items are accounted for under FASB Statement No. 133 and its
related interpretations, and (iii.) how derivative instruments and related
hedged items affect and entity's financial position, financial performance and
cash flows. SFAS 161 is effective for financial statements issued for years and
interim periods beginning after November 15, 2008 (our year ended February 27,
2010). The effect of adopting SFAS 161 is not expected to have a significant
effect on our reported financial position or earnings.
In April 2008, the FASB issued FSP 142-3, Determining the Useful Life of
Intangible Assets ("FSP 142-3"). FSP 142-3 amends the factors to be considered
in determining the useful life of intangible assets. Its intent is to improve
the consistency between the useful life of an intangible asset and the period of
expected cash flows used to measure its fair value. FSP 142-3 is effective for
fiscal years beginning after December 15, 2008 (our year ended February 27,
2010). Our Company is currently assessing the impact of FSP 142-3 on our
consolidated financial statements.
In May 2008, the FASB issued Statement No. 162, "The Hierarchy of Generally
Accepted Accounting Principles" ("SFAS 162"). The new standard is intended to
improve financial reporting by identifying a consistent framework, or hierarchy,
for selecting accounting principles to be used in preparing financial statements
that are presented in conformity with U.S. generally accepted accounting
principles ("GAAP") for nongovernmental entities. Prior to the issuance of SFAS
162, GAAP hierarchy was defined in the American Institute of Certified Public
Accountants ("AICPA") Statement on Auditing Standards (SAS) No. 69, The Meaning
of Present Fairly in Conformity With Generally Accepted Accounting Principles.
SAS 69 has been criticized because it is directed to the auditor rather than the
entity. SFAS 162 addresses these issues by establishing that the GAAP hierarchy
should be directed to entities because it is the entity, not its auditor, that
is responsible for selecting accounting principles for financial statements that
are presented in conformity with GAAP.
SFAS 162 is effective 60 days following the SEC's approval of the Public Company
Accounting Oversight Board Auditing amendments to AU Section 411, The Meaning of
Present Fairly in Conformity with Generally Accepted Accounting Principles. It
is only effective for nongovernmental entities; therefore, the
8
GAAP hierarchy will remain in SAS 69 for state and local governmental entities
and federal governmental entities. We have evaluated the provisions of SFAS 162
and the guidance will not have an impact on our Company's financial condition or
results of operations.
In May 2008, the FASB issued Staff Position No. APB 14-1, Accounting for
Convertible Debt Instruments that May be Settled in Cash Upon Conversion ("FSP
APB 14-1"). FSP APB 14-1 requires that the liability and equity components of
convertible debt instruments that may be settled in cash upon conversion
(including partial cash settlement) be separately accounted for in a manner that
reflects an issuer's nonconvertible debt borrowing rate. FSP APB 14-1 is
effective for financial statements issued for fiscal years beginning after
December 15, 2008 (our year ended February 27, 2010), and interim periods within
those fiscal years; however, early adoption is not permitted. Retrospective
application to all periods presented is required except for instruments that
were not outstanding during any of the periods that will be presented in the
annual financial statements for the period of adoption but were outstanding
during an earlier period. We are currently assessing the impact of adopting FSP
APB 14-1 on our financial condition and results of operations.
3. Acquisition of Pathmark Stores, Inc.
On December 3, 2007, our Company completed the acquisition of 100% of Pathmark
for $1.4 billion in cash, stock, assumed or retired debt, warrants and options,
in a transaction accounted for under SFAS No. 141 "Business Combinations" ("SFAS
141"). Pathmark is a regional supermarket chain with supermarkets in the New
York, New Jersey and Philadelphia metropolitan areas.
Consent Agreement
-----------------
On November 27, 2007, our Company announced that the Federal Trade Commission
("FTC") accepted a proposed consent agreement relating to our acquisition of
Pathmark. The terms of the consent agreement required the divestiture of six
stores located in the state of New York which were subsequently sold for a gain
of $19.4 million in fiscal 2007.
Included in the Consolidated Statements of Operations for the 16 weeks ended
June 14, 2008 and June 16, 2007 are the sales and operating results of the five
A&P stores that were divested. The sixth divested store was a Pathmark location
and accordingly the results of operations of that store were not included in our
results of operations. The results of the five A&P store operations are as
follows:
16 weeks ended
-------------------------------
June 14, 2008 June 16, 2007
------------- -------------
Sales $ - $ 34,057
=========== ============
Income from operations $ - $ 343
=========== ============
Preliminary Purchase Price Allocation
-------------------------------------
The application of purchase accounting under SFAS 141 requires that the purchase
price paid is allocated to the tangible and identifiable intangible assets
acquired and liabilities assumed on the basis of their fair values on the
transaction date. The allocation of the purchase price and its impact on the
Consolidated Statements of Operations may differ depending on the final fair
values assigned to amortizing assets and
9
liabilities and their related actual remaining useful lives. Identified
intangible assets, which are included in the consolidated balance sheets,
consisted of the following:
At June 14, 2008
---------------------------------
Weighted
Average Gross
Amortization Carrying Accumulated
Period (years) Amount Amortization
-------------- ----------- ---------------
Loyalty card customer relationships 7 $ 19,200 $ 1,477
In-store advertiser relationships 20 14,720 396
Pharmacy payor relationships 13 75,000 3,107
Pathmark trade name Indefinite 127,300 -
----------- ---------------
Total $ 236,220 $ 4,980
=========== ==============
Amortization of intangible assets for the 16 weeks ended June 14, 2008 was
approximately $2.8 million.
The following table summarizes the estimated future amortization expense:
2008 $ 6,402
2009 9,248
2010 9,248
2011 9,248
2012 9,248
Thereafter 60,546
We have determined that the Pathmark trade name has an indefinite life, and
accordingly, is not subject to amortization. The allocation of the purchase
price to assets which will not be amortized may also impact classification on
the balance sheet depending on the final fair values assigned.
Under the purchase method of accounting, the assets and liabilities of Pathmark
were recorded at their respective fair values at the date of acquisition.
Simultaneously, we recorded a preliminary amount to goodwill of $380.0 million.
During the first quarter of fiscal 2008, we increased our preliminary amount of
goodwill from $380.0 million to $440.1 million at June 14, 2008. This increase
primarily related to a Pathmark transportation agreement which is unfavorable to
market based upon information which existed as of the acquisition. We are
performing additional analyses of this information which may result in future
adjustments. Based upon the information received to date, we recorded an
adjustment of approximately $59.0 million to our preliminary amount of goodwill.
This adjustment also resulted in a $2.2 million reduction of operating expense
in the first quarter of fiscal 2008 relating to prior year.
We have preliminarily valued property, net, intangible assets, and certain other
assets and liabilities. As this transaction was completed subsequent to our
third quarter ended December 1, 2007, the values of certain assets and
liabilities are based on preliminary valuations and are subject to adjustment as
additional information is obtained. Changes to the valuation of property may
result in adjustments to the fair value of certain identifiable intangible
assets acquired, and when finalized, material adjustments to goodwill may
result.
10
The following table summarizes the preliminary estimated fair values of the
Pathmark assets acquired and liabilities assumed at the date of acquisition:
Current assets $ 352.4
Goodwill 440.1
Intangible assets 236.2
Property, net* 1,200.5
Other assets 148.7
---------
Total assets acquired $ 2,377.9
Current liabilities (325.2)
Long-term debt (1.2)
Long-term obligations under capital leases (130.5)
Long-term financing liabilities (64.1)
Deferred taxes** (58.6)
Other non-current liabilities (385.8)
---------
Total liabilities assumed $ (965.4)
---------
Net assets acquired $ 1,412.5
=========
* In fiscal 2007, we acquired net favorable lease rights relating to the
acquisition of Pathmark in the amount of $457.0 million which is
included in Property, net and other non-current liabilities in our
Consolidated Balance Sheet at June 14, 2008. The Company's net
favorable lease rights are amortized on a straight-line basis until the
end of the lease options but not more than 25 years. The weighted
average life remaining of the net favorable lease rights at June 14,
2008 is 21.3 years. Amortization expense related to the net favorable
lease rights is $7.0 million for the 16 weeks ended June 14, 2008.
** The estimated fair values reflect recognition of a significant portion
of A&P's net deferred tax assets, including net operating loss carry
forwards, which existed at the date of acquisition.
The preliminary amount of goodwill and intangibles are approximately $440.1
million and $236.2 million, respectively, resulting from the Pathmark
acquisition. The goodwill is not deductible for tax purposes. Due to the recent
nature of the acquisition we have not determined the reporting units to which
the goodwill related to the Pathmark acquisition will be allocated.
4. Earnings Per Share
Basic earnings (loss) per share is computed by dividing net income (loss) by the
weighted average shares outstanding for the reporting period. Diluted earnings
(loss) per share reflects the potential dilution, using the treasury stock
method, and assumes that the convertible debt, stock options, restricted stock,
warrants, and other potentially dilutive financial instruments were converted
into common stock upon issuance, if dilutive.
Weighted average common shares of 1,030,969 and nil for the 16 weeks ended June
14, 2008 and June 16, 2007, respectively, related to options outstanding under
our Company's stock award plan were excluded from the computation of diluted
earnings per share as the effect would be antidilutive.
Weighted average common shares of 10,000 for the 16 weeks ended June 14, 2008
related to restricted stock units outstanding under our Company's stock option
plans were excluded from the computation of diluted earnings per share as the
effect would be antidilutive.
Weighted average common shares of 4,969,401 for the 16 weeks ended June 14, 2008
related to warrants outstanding under our Company's stock award plan were
excluded from the computation of diluted earnings per share as the effect would
be antidilutive.
11
Weighted average common shares of 11,278,988 for the 16 weeks ended June 14,
2008 related to convertible debt outstanding were excluded from the computation
of diluted earnings per share as the effect would be antidilutive.
Weighted average common shares of 8,134,002 for the 16 weeks ended June 14, 2008
related to the share lending agreement were excluded from the computation of
earning per share.
The following table sets forth the calculation of basic and diluted earnings per
share:
16 Weeks Ended 16 Weeks Ended
June 14, 2008 June 16, 2007
--------------- ---------------
Income (loss) from continuing operations $ 3,765 $ (65,142)
Adjustments on Convertible Warrants (27,119) -
--------------- ---------------
Loss from continuing operations-diluted $ (23,354) $ (65,142)
=============== ================
Weighted average common shares outstanding 57,606,833 41,801,381
Restricted stock options 313,196 -
Share lending agreement (8,134,002) -
--------------- ---------------
Common shares outstanding-basic 49,786,027 41,801,381
Effect of dilutive securities:
Options to purchase common stock 243,721 458,456
Convertible warrants (1,873,094) -
--------------- ---------------
Common shares outstanding-diluted 48,156,654 42,259,837
============== ===============
5. Cash, Cash Equivalents, Restricted Cash and Restricted Marketable Securities
At June 14, 2008 and February 23, 2008, we had $3.8 million and $3.7 million,
respectively, in restricted cash which represented monies held in escrow for
services which our Company is required to perform in connection with the sale of
our real estate properties.
At June 14, 2008 and February 23, 2008, our restricted marketable securities of
$18.2 million and $19.4 million, respectively, were held by Bank of America in
the Columbia Fund. On December 6, 2007, Bank of America froze the Columbia Fund
as a result of the increased risk in subprime asset backed securities. During
the first quarter of fiscal 2008, we received distributions from the Columbia
Fund in the amount of $1.0 million at an amount less than 100% of the net asset
value of the fund resulting in realized losses of $0.03 million. In addition, we
recorded a realized loss of $0.3 million based on the ending net asset value of
the Columbia Fund as the decline in net asset value is considered other than
temporary at June 14, 2008 and will not be recovered in future distributions
from the fund.
Effective March 13, 2007, in accordance with SFAS 115, "Accounting for Certain
Investments in Debt and Equity Securities," we record changes in the fair value
of Metro, Inc. as unrealized gains or losses, net of tax, as a component of
accumulated other comprehensive loss in our Consolidated Balance Sheets
based on the close price of Metro, Inc. at the end of our reporting period.
12
The following is a summary of cash, cash equivalents, restricted cash, and
restricted marketable securities as of June 14, 2008 and February 23, 2008:
At June 14, 2008
-----------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Costs Gains Losses Value
------------- ------------- ------------- -------------
Classified as:
-------------
Cash $ 126,995 $ - $ - $ 126,995
Cash equivalents:
Money market funds 2,058 - - 2,058
----------- ----------- ----------- -----------
Total cash and cash equivalents 129,053 - - 129,053
----------- ----------- ----------- -----------
Restricted cash 3,781 - - 3,781
Restricted marketable securities 7,119 - - 7,119
Restricted marketable securities
included in other assets 11,071 - - 11,071
----------- ----------- ----------- -----------
Total cash, cash equivalents, restricted cash and
restricted marketable securities $ 151,024 $ - $ - $ 151,024
=========== =========== =========== ===========
Securities available-for-sale:
------------------------------
Maturing within one year $ 7,119 $ 7,119
=========== ===========
Maturing greater than one year $ 11,071 $ 11,071
=========== ===========
At February 23, 2008
-----------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Costs Gains Losses Value
------------- ------------- ------------- -------------
Classified as:
-------------
Cash $ 98,382 $ - $ - $ 98,382
Cash equivalents:
Money market funds 2,351 - - 2,351
----------- ----------- ----------- -----------
Total cash and cash equivalents 100,733 - - 100,733
----------- ----------- ----------- -----------
Restricted cash 3,713 - - 3,713
Restricted marketable securities 6,796 - - 6,796
Restricted marketable securities
included in other assets 12,622 - - 12,622
----------- ----------- ----------- -----------
Total cash, cash equivalents, restricted cash and
restricted marketable securities $ 123,864 $ - $ - $ 123,864
=========== =========== =========== ===========
Securities available-for-sale:
------------------------------
Maturing within one year $ 6,796 $ 6,796
=========== ===========
Maturing greater than one year $ 12,622 $ 12,622
=========== ===========
Gross realized losses on sales of investments were $0.03 million for the 16
weeks ended June 14, 2008 and gross realized gains on sales of investments were
$78.5 million for the 16 weeks ended June 16, 2007.
13
6. Fair Value Measurements
SFAS 157 defines and establishes a framework for measuring fair value and
expands related disclosures. This Statement applies to all assets and
liabilities that are being measured and reported on a fair value basis. Our
Company adopted SFAS 157 for our financial assets and financial liabilities
beginning in fiscal 2008. As discussed in Note 2 - Impact of New Accounting
Pronouncements, SFAS 157-2 deferred the effective date of SFAS 157 for all
nonfinancial assets and nonfinancial liabilities recorded at fair value on a
nonrecurring basis to fiscal years beginning after November 15, 2008 (our year
ended February 27, 2010).
SFAS 157 establishes a three-tier fair value hierarchy, which classifies the
inputs used in measuring fair value. These tiers include:
Level 1 - Quoted prices in active markets for identical assets or liabilities.
Our Company's Level 1 assets and liabilities include cash equivalents that are
traded in an active exchange market.
Level 2 - Observable inputs other than Level 1 prices, such as quoted prices for
similar assets or liabilities; or other inputs that are observable or can be
corroborated by observable market data for substantially the full term of the
assets or liabilities. Our Company's Level 2 liabilities primarily include
freestanding derivatives (conversion features and financing warrants) and
warrants whose value is determined using the Black Scholes pricing model with
inputs that are observable in the market or can be derived principally from or
corroborated by observable market data.
Level 3 - Unobservable inputs that are supported by little or no market activity
and that are financial instruments whose value is determined using pricing
models, discounted cash flows, or similar methodologies, as well as instruments
for which the determination of fair value requires significant judgment or
estimation. Our Company's Level 3 assets include restricted marketable
securities for which there is limited market activity.
A financial asset or liability's classification within the hierarchy is
determined based on the lowest level input that is significant to the fair value
measurement.
The following table provides the assets and liabilities carried at fair value
measured on a recurring basis as of June 14, 2008:
Fair Value Measurements at June 14, 2008 Using
----------------------------------------------
Significant
Quoted Prices Other Significant
Total Carrying in Active Observable Unobservable
Value at Markets Inputs Inputs
June 14, 2008 (Level 1) (Level 2) (Level 3)
----------------- ------------- ------------- -------------
Assets:
Cash equivalents $ 2,058 $ 2,058 $ - $ -
Restricted marketable securities 18,190 - - 18,190
----------------- ------------- ------------- -------------
Total $ 20,248 $ 2,058 $ - $ 18,190
================= ============= ============= =============
14
Fair Value Measurements at June 14, 2008 Using
----------------------------------------------
Significant
Quoted Prices Other Significant
Total Carrying in Active Observable Unobservable
Value at Markets Inputs Inputs
June 14, 2008 (Level 1) (Level 2) (Level 3)
----------------- ------------- ------------- -------------
Liabilities:
Conversion feature of 5.125% Convertible
Senior Notes $ 8,533 $ - $ 8,533 $ -
Conversion feature of 6.75% Convertible
Senior Notes - - - -
Financing warrants 24,699 - 24,699 -
Warrant Series B 78,983 - 78,983 -
----------------- ------------- ------------- -------------
Total $ 112,215 $ - $ 112,215 $ -
================= ============= ============= =============
Level 3 Valuation Techniques:
----------------------------
Financial assets are considered Level 3 when their fair values are determined
using pricing models, discounted cash flows or similar techniques and at least
one significant model assumption or input is unobservable. Level 3 financial
assets include our restricted marketable securities for which there is limited
market activity such that the determination of fair value requires significant
judgment or estimation. At June 14, 2008, these securities were valued primarily
using broker pricing models that incorporate transaction details such as
contractual terms, maturity, timing and amount of future cash inflows, as well
as assumptions about liquidity.
The table below provides a summary of the changes in fair value, including net
transfers in and/or out, of all financial assets measured at fair value on a
recurring basis using significant unobservable inputs (Level 3) for the period
February 24, 2008 to June 14, 2008:
Fair Value Measurements Using
Significant Unobservable Inputs
(Level 3)
-------------------------------
Restricted
Marketable
Securities
-------------
Beginning Balance $ 19,418
Total realized and unrealized losses included in:
Earnings (1) (290)
Comprehensive income -
Settlements (938)
Transfers in and/or out of Level 3 -
-------------
Ending Balance $ 18,190
=============
Losses recorded in Earnings attributable to the change in unrealized losses
relating to Level 3 assets still held at June 14, 2008 $ (262)
=============
(1) Amounts are recorded in Store operating, general and administrative expense
in the Consolidated Statements of Operations.
15
As discussed in Note 5 - Cash, Cash Equivalents, Restricted Cash and Restricted
Marketable Securities, on June 14, 2008, we had $18.2 million invested in a
short-term fixed income fund held by Bank of America (the "Columbia Fund"). Due
to market liquidity conditions, cash redemptions from the Columbia Fund were
restricted. As a result of this restriction on cash redemptions, we did not
consider the Columbia Fund to be traded in an active market with observable
pricing on February 24, 2008 and these amounts were categorized as Level 3.
7. Valuation of Long-Lived Assets
In accordance with SFAS 144, "Accounting for the Impairment or Disposal of
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 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 14, 2008 and June 16, 2007, we recorded
impairment losses on long-lived assets of $0.8 million and $50.2 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 14, 2008 and June 16, 2007, we recorded
impairment losses on property, plant and equipment of $0.8 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 discontinued operations
--------------------------------------------------
During the 16 weeks ended June 16, 2007, we recorded impairment losses of $49.7
million related to stores closed as a result of our exit of the Greater New
Orleans and Midwest markets as discussed in Note 8 - Discontinued Operations.
This amount was included in our Consolidated Statements of Operations under the
caption "Gain (loss) on disposal of discontinued operations, net of tax".
The effects of changes in estimates of useful lives were not material to ongoing
depreciation expense.
8. Discontinued Operations
We have had multiple transactions throughout the years which met the criteria
for discontinued operations. These events are described based on the year the
transaction was initiated.
2007 Events
-----------
On May 30, 2007, our Company announced advanced negotiations for the sale of our
non-core stores located within the Greater New Orleans area, including inventory
related to these stores. Our Company ceased sales operations in all stores not
sold as of November 1, 2007. Planned sale transactions for these stores have
been completed resulting in a loss on disposal of $16.5 million.
16
On April 24, 2007, based upon unsatisfactory operating trends and the need to
devote resources to our expanding Northeast core business, our Company announced
negotiations for the sale of our non-core stores within our Midwest operations,
including inventory related to these stores. Our Company ceased sales operations
in all stores not sold as of July 7, 2007. Planned sale transactions for these
stores have been completed resulting in a loss on disposal of $34.3 million.
2005 Event
----------
During the first quarter of fiscal 2005, we announced plans for a major
strategic restructuring that would consolidate efforts in the Midwest. Thus, we
initiated efforts to close a total of 35 stores in the Midwest. All of which
were closed as of February 25, 2006.
2003 Events
-----------
During fiscal 2003, we adopted a formal plan to exit the Wisconsin markets
through the sale and/or disposal of these assets. In February 2003, we announced
the sale of a portion of our non-core assets, including seven stores in Madison,
Wisconsin and 23 stores in Milwaukee, Wisconsin. Also in fiscal 2003, we
announced an initiative to close 6 stores and convert 13 stores to our Food
Basics banner in the Detroit, Michigan and Toledo, Ohio markets.
Summarized below are the operating results for these discontinued businesses,
which are included in our Consolidated Statements of Operations, under the
captions "Loss from operations of discontinued businesses, net of tax" and "Gain
(loss) on disposal of discontinued businesses, net of tax" for the 16 weeks
ended June 14, 2008 and June 16, 2007.
For the 16 weeks ended
----------------------------------------
June 14, 2008 June 16, 2007
------------------ ----------------
Loss from operations of
discontinued businesses
Sales $ - $ 422,327
============== ==============
Loss from operations of
discontinued businesses, before tax (4,163) (79,780)
Tax benefit - -
-------------- --------------
Loss from operations of
discontinued operations, net of tax $ (4,163) $ (79,780)
=============== ===============
Gain (loss) on disposal of
discontinued operations
Property impairments $ - $ (49,703)
Gain on sale of fixed assets 2,639 2,935
-------------- --------------
Gain (loss) on disposal of
discontinued operations, before tax 2,639 (46,768)
Tax benefit - -
-------------- --------------
Gain (loss) on disposal of
discontinued operations, net of tax $ 2,639 $ (46,768)
============== ===============
17
Summarized below is a reconciliation of the liabilities related to restructuring
obligations resulting from these activities, pursuant to SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities" and SFAS No.
112, "Employers' Accounting for Postemployment Benefits."
For the 16 weeks ended June 14, 2008
--------------------------------------------------------------------------------------
Balance at Interest Balance at
2/23/2008 Accretion (1) Adjustments(2) Utilization(3) 6/14/2008
--------------- --------------- --------------- -------------- ----------------
2007 Events
-----------
Occupancy $ 62,873 $ 2,876 $ 914 $ (8,827) $ 57,836
Severance 58,520 - - (1,073) 57,447
--------------- -------------- --------------- -------------- ----------
2007 events total 121,393 2,876 914 (9,900) 115,283
2005 Event
----------
Occupancy 66,882 993 (906) (3,048) 63,921
2003 Events
-----------
Occupancy 21,579 407 (1,559) (1,228) 19,199
--------------- -------------- --------------- -------------- ----------
Fiscal 2008 total $ 209,854 $ 4,276 $ (1,551) $ (14,176) $ 198,403
=============== ============== =============== =============== ==========
Fiscal 2007
--------------------------------------------------------------------------------------
Balance at Interest Balance at
2/24/2007 Accretion (1) Adjustments(2) Utilization(3) 2/23/2008
--------------- --------------- --------------- -------------- ----------------
2007 Events
-----------
Occupancy $ - $ 2,865 $ 81,234 $ (21,226) $ 62,873
Severance - - 81,642 (23,122) 58,520
--------------- -------------- --------------- -------------- -----------
2007 events total - 2,865 162,876 (44,348) 121,393
2005 Event
----------
Occupancy 83,111 3,457 (7,117) (12,569) 66,882
2003 Events
-----------
Occupancy 22,262 1,269 1,141 (3,093) 21,579
--------------- -------------- --------------- -------------- ----------
Fiscal 2007 total $ 105,373 $ 7,591 $ 156,900 $ (60,010) $ 209,854
=============== ============== =============== ================= ==========
(1) The additions to occupancy and severance represents 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. Interest accretion
is recorded as a component of "Loss from operations of discontinued
business" on the Consolidated Statements of Operations.
(2) At each balance sheet date, we assess the adequacy of the balance of
the remaining liability to determine if any adjustments are required as
a result of changes in circumstances and/or estimates. Adjustments are
recorded as a component of "Loss from operations of discontinued
business" on the Consolidated Statements of Operations.
For the 16 weeks ended June 14, 2008
------------------------------------
The charge to occupancy for the 2007 events represents adjustments for
additional occupancy related costs for our properties of $0.9 million
due to changes in our estimation of such future costs. We also recorded
adjustments for a reduction in occupancy related costs of $0.9 million
and $1.6 million for the 2005 event and the 2003 events, respectively,
due to changes in our estimation of such future costs.
18
Fiscal 2007
-----------
The charge to occupancy for the 2007 events represents charges related
to the closures of 39 stores in fiscal 2007 in conjunction with our
decision to close and/or sell stores in the Midwest and the Greater New
Orleans area. The charge to severance and benefits of $81.6 million for
the 2007 events related to (i.) individual severings and retention
incentives that were accrued as earned of $24.6 million as a result of
the sale or closing of these facilities and (ii.) future obligations
for early withdrawal from multi-employer union pension plans of $57.0
million. During fiscal 2007, we also recorded adjustments for the 2005
event for a reduction in occupancy related costs for our properties of
$7.1 million due to (i.) changes in our estimation of such future costs
of $6.4 million and (ii.) a new sublease agreement for one property of
$0.7 million. We recorded adjustments for the 2003 events for
additional occupancy related costs for our properties of $1.1 million
due to changes in our estimation of such future costs.
(3) Occupancy utilization represents payments made during those periods for
rent, common area maintenance and real estate taxes. Severance
utilization represents payments made to terminated employees during the
period.
Summarized below are the payments made to date from the time of the original
charge and expected future payments related to these events:
2007 2005 2003
Events Event Events
-------------- --------------- -------------
Total severance payments made to date $ 24,195 $ 2,650 $ 22,528
Expected future severance payments 57,447 - -
-------------- --------------- -------------
Total severance payments expected to be incurred 81,642 2,650 $ 22,528
-------------- --------------- -------------
Total occupancy payments made to date 30,053 39,220 27,554
Expected future occupancy payments,
excluding interest accretion 57,836 63,921 19,199
Total occupancy payments expected to be incurred,
-------------- --------------- -------------
excluding interest accretion 87,889 103,141 46,753
-------------- --------------- -------------
Total severance and occupancy payments made to date 54,248 41,870 50,082
Expected future severance and occupancy payments,
excluding interest accretion 115,283 63,921 19,199
Total severance and occupancy payments - - -
expected to be incurred, excluding interest accretion $ 169,531 $ 105,791 $ 69,281
=============== ============= ============
Payments to date were primarily for occupancy related costs such as rent, common
area maintenance, real estate taxes, lease termination costs, severance, and
benefits. The remaining obligation relates to expected future payments under
long term leases and expected future payments for early withdrawal from
multi-employer union pension plans. The expected completion dates for the 2007,
2005, and 2003 events are 2026, 2022, and 2022, respectively.
Summarized below are the amounts included in our balance sheet captions on our
Company's Consolidated Balance Sheets related to these events:
June 14, 2008
-----------------------------------------------------------------
2007 2005 2003
Events Event Events Total
--------------- --------------- --------------- ---------------
Accrued salaries, wages and benefits $ 440 $ - $ - $ 440
Other accruals $ 23,684 $ 10,485 $ 2,791 $ 36,960
Other non-current liabilities $ 91,159 $ 53,436 $ 16,408 $ 161,003
19
February 23, 2008
-----------------------------------------------------------------
2007 2005 2003
Events Event Events Total
--------------- --------------- --------------- ---------------
Accrued salaries, wages and benefits $ 1,513 $ - $ - $ 1,513
Other accruals $ 24,733 $ 10,985 $ 3,241 $ 38,959
Other non-current liabilities $ 95,147 $ 55,897 $ 18,338 $ 169,382
We evaluated the reserve balances as of June 14, 2008 based on current
information and have concluded that they are adequate to cover future costs. We
will continue to monitor the status of the vacant and subsidized properties,
severance and benefits, and pension withdrawal liabilities, and adjustments to
the reserve balances may be recorded in the future, if necessary.
9. Asset Disposition Initiatives
In addition to the events described in Note 8 - Discontinued Operations, there
were restructuring transactions which were not primarily related to our
discontinued operations businesses. These events are referred to based on the
year the transaction was initiated, as described below.
Restructuring charges relate principally to employee severance and occupancy
costs resulting from the closure of facilities and other workforce reductions
attributable to our efforts to reduce costs. The costs of these reductions have
been and will be funded through cash from operations. Occupancy costs represent
facility consolidation and lease termination costs associated with our decision
to consolidate and close duplicative or excess warehouse and office facilities,
unproductive and excess facilities and the continued softening of real estate
markets, which resulted in lower than expected sublease income.
2005 Event
---------
During fiscal 2005, our Company sold 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.
2001 Event
----------
During the third quarter of fiscal 2001, our Company determined that certain
underperforming operations, including 39 stores (30 in the United States and 9
in Canada) and 3 warehouses (2 in the United States and 1 in Canada) should be
closed and/or sold, and certain administrative streamlining should take place.
1998 Event
----------
In May 1998, we initiated an assessment of our business operations in order to
identify the factors that were impacting our performance. As a result of this
assessment, in fiscal 1998 and 1999, we announced a plan to close two warehouse
facilities and a coffee plant in the U.S., a bakery plant in Canada and 166
stores (156 in the United States and 10 in Canada) including the exit of the
Richmond, Virginia and Atlanta, Georgia markets.
20
Summarized below is a reconciliation of the liabilities related to restructuring
obligations resulting from these activities, pursuant to SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities" and SFAS No.
112, "Employers' Accounting for Postemployment Benefits."
For the 16 weeks ended June 14, 2008
------------------------------------------------------------------------------------
Balance at Interest Balance at
2/23/2008 Accretion (1) Adjustments(2) Utilization(3) 6/14/2008
--------------- --------------- --------------- --------------- --------------
2005 Event
----------
Continuing Operations
Occupancy $ 1,231 $ 15 $ (91) $ (12) $ 1,143
Severance 1,686 - - (209) 1,477
-------------- -------------- --------------- ----------------- ----------
2005 event total 2,917 15 (91) (221) 2,620
2001 Event
----------
Continuing Operations
Occupancy 6,755 113 (501) (86) 6,281
Discontinued Operations
Occupancy 12,281 219 (166) (467) 11,867
--------------- -------------- --------------- -------------- ----------
2001 event total 19,036 332 (667) (553) 18,148
1998 Event
----------
Continuing Operations
Occupancy 6,958 108 268 (897) 6,437
Severance 1,000 - - (50) 950
Discontinued Operations
Occupancy 1,093 19 (8) (183) 921
--------------- -------------- --------------- -------------- ----------
1998 event total 9,051 127 260 (1,130) 8,308
--------------- -------------- --------------- -------------- ----------
Fiscal 2008 total $ 31,004 $ 474 $ (498) $ (1,904) $ 29,076
=============== ============== =============== ============== ==========
21
Fiscal 2007
------------------------------------------------------------------------------------
Balance at Interest Balance at
2/24/2007 Accretion (1) Adjustments(2) Utilization(3) 2/23/2008
--------------- --------------- --------------- --------------- --------------
2005 Event
----------
Continuing Operations
Occupancy $ 1,453 $ 51 $ 200 $ (473) $ 1,231
Severance 876 - 2,366 (1,556) 1,686
Discontinued Operations
Occupancy 3,997 92 (3,197) (892) -
--------------- -------------- --------------- -------------- ----------
2005 event total 6,326 143 (631) (2,921) 2,917
2001 Event
----------
Continuing Operations
Occupancy 7,338 401 10 (994) 6,755
Discontinued Operations
Occupancy 13,248 747 - (1,714) 12,281
--------------- -------------- --------------- -------------- ----------
2001 event total 20,586 1,148 10 (2,708) 19,036
1998 Event
----------
Continuing Operations
Occupancy 9,438 429 (351) (2,558) 6,958
Severance 1,210 - - (210) 1,000
Discontinued Operations
Occupancy 1,598 79 - (584) 1,093
1998 event total 12,246 508 (351) (3,352) 9,051
--------------- -------------- --------------- -------------- ----------
Fiscal 2007 total $ 39,158 $ 1,799 $ (972) $ (8,981) $ 31,004
=============== ============== =============== ============== ==========
(1) Represents the interest accretion on future occupancy costs which were
recorded at present value at the time of the original charge. These
adjustments are recorded to "Store operating, general and
administrative expense" for continuing operations and "Loss from
operations of discontinued operations" for discontinued operations on
our Consolidated Statements of Operations.
(2) 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. These adjustments are recorded to
"Store operating, general and administrative expense" for continuing
operations and "Loss from operations of discontinued operations" as
noted for discontinued operations on our Consolidated Statements of
Operations.
For the 16 weeks ended June 14, 2008
------------------------------------
For the 16 weeks ended June 14, 2008, we recorded adjustments for a
reduction in occupancy related costs of $0.1 million and $0.7 million
for the 2005 event and the 2001 event, respectively, due to changes in
our estimation of such future costs. We also recorded an adjustment for
additional occupancy related costs of $0.3 million for the 1998 event
due to changes in our estimation of such future costs.
Fiscal 2007
-----------
During fiscal 2007, adjustments to occupancy costs related to changes
in our estimation of such future costs. We recorded additions to
severance of $2.4 million for the 2005 event for health and welfare
benefits for warehouse retirees of $1.7 million and pension withdrawal
costs of $0.7 million.
22
(3) Occupancy utilization represents payments made during those periods for
rent. Severance and benefits utilization represents payments made to
terminated employees during the period.
Summarized below are the payments made to date from the time of the original
charge and expected future payments related to these events:
2005 2001 1998
Event Event Event Total
-------------- ------------- ---------------- -------------
Total severance payments made to date $ 48,142 $ 28,205 $ 30,514 $ 106,861
Expected future severance payments 1,477 - 950 2,427
Total severance payments expected ----------- ---------- ------------- ----------
to be incurred 49,619 28,205 31,464 109,288
----------- ---------- ------------- ----------
Total occupancy payments made to date 13,789 59,573 113,025 186,387
Expected future occupancy payments,
excluding interest accretion 1,143 18,148 7,358 26,649
Total occupancy payments expected
to be incurred, excluding interest ----------- ---------- ------------- ----------
accretion 14,932 77,721 120,383 213,036
----------- ---------- ------------- ----------
Total severance and occupancy
payments made to date $ 61,931 $ 87,778 $ 143,539 $ 293,248
Expected future severance and
occupancy payments, excluding
interest accretion 2,620 18,148 8,308 29,076
Total severance and occupancy
payments expected to be incurred, ----------- ---------- ------------- ----------
excluding interest accretion $ 64,551 $ 105,926 $ 151,847 $ 322,324
=========== ========== ============= ==========
Payments to date were primarily for occupancy related costs such as rent, common
area maintenance, real estate taxes, lease termination costs, severance, and
benefits. The remaining obligation relates to expected future payments under
long-term leases and expected future payments for early withdrawal from
multi-employer union pension plans. The expected completion dates for the 2005,
2001 and 1998 events are 2021, 2022 and 2020, respectively.
Summarized below are the amounts included in our balance sheet captions on our
Company's Consolidated Balance Sheets related to these events:
June 14, 2008
---------------------------------------------------------------------
2005 2001 1998
Event Event Event Total
--------------- --------------- ------------- ----------------
Other accruals $ 404 $ 2,760 $ 2,797 $ 5,961
Other non-current liabilities $ 2,216 $ 15,388 $ 5,511 $ 23,115
23
February 23, 2008
---------------------------------------------------------------------
2005 2001 1998
Event Event Event Total
--------------- --------------- --------------- ----------------
Other accruals $ 434 $ 2,754 $ 2,827 $ 6,015
Other non-current liabilities $ 2,483 $ 16,282 $ 6,224 $ 24,989
We evaluated the reserve balances as of June 14, 2008 based on current
information and have concluded that they are adequate to cover future costs. We
will continue to monitor the status of the vacant and subsidized properties,
severance and benefits, and pension withdrawal liabilities, and adjustments to
the reserve balances may be recorded in the future, if necessary.
10. Indebtedness and Other Financial Liabilities
Series A and B Warrants
-----------------------
As part of the acquisition of Pathmark on December 3, 2007, we issued 4,657,378
and 6,965,858 roll-over stock warrants in exchange for Pathmark's 2005 Series A
and Series B warrants, respectively. The number of warrants issued was computed
based on the conversion factor of 0.46296. The Series A warrants were
exercisable at $18.36 and expired on June 9, 2008 and the Series B warrants are
exercisable at $32.40 and expire on June 9, 2015. These warrants were originally
valued using the price of A&P common stock of $30.05 per common share, the
quoted market price of A&P common stock on November 30, 2007, the last trading
day before the transaction closing date. The Tengelmann stockholders have the
right to approve any issuance of common stock under these warrants upon exercise
(assuming Tengelmann's outstanding interest is at least 25% and subject to
liquidity impairments defined within the Tengelmann Stockholder Agreement). In
addition, Tengelmann has the ability to exercise a "Put Right" whereby it has
the ability to require A&P to purchase A&P stock held by Tengelmann to settle
these warrants. Based on the rights provided to Tengelmann, A&P does not have
sole discretion to determine whether the payment upon exercise of these warrants
will be settled in cash or through issuance of an equivalent portion of A&P
shares. Therefore, these warrants are recorded as liabilities and
marked-to-market each reporting period based on A&P's current stock price.
On May 7, 2008, the 4,657,378 Series A warrants were exercised by Yucaipa
Corporate Initiatives Fund I, L.P., Yucaipa American Alliance Fund I, L.P. and
Yucaipa American Alliance (Parallel) Fund I, L.P. We opted to settle the Series
A warrants in cash totaling $45.7 million rather than issuing additional common
shares.
Included in "Nonoperating Income" on our Consolidated Statements of Operations
for the 16 weeks ended June 14, 2008, is a loss of $1.2 million for the Series A
warrants through the settlement date of May 7, 2008 and a gain of $27.1 million
for the Series B warrants market value adjustment. The value of the Series B
warrants were $79.0 million as of June 14, 2008 and is included in "Other
financial liabilities" on our Consolidated Balance Sheets. The following
assumptions and estimates were used in the Black-Scholes model:
Series B
---------------
Expected life 7.0 years
Volatility 51.8%
Dividend yield range 0%
Risk-free interest rate range 3.95%
24
Public Debt Obligations
-----------------------
On December 18, 2007, we completed a public offering and issued $165 million
5.125% convertible senior notes due 2011 and $255 million 6.75% convertible
senior notes due 2012. The 2011 notes are not redeemable at our option at any
time. The 2012 notes are redeemable at our option on or after December 15, 2010,
at a redemption price of 102.70% and on or after December 15, 2011, at a
redemption price of 101.35%. The initial conversion price of the 2011 notes is
$36.40 representing a 30.0% premium to the offering price of $28.00 and the
initial conversion price of the 2012 notes is $37.80 representing a 35.0%
premium to the offering price of $28.00 at maturity, and at our option, the
notes are convertible into shares of our stock, cash, or a combination of stock
and cash. Concurrent with this offering, we entered into call options and
financing warrant transactions with financial institutions that are affiliates
of the underwriters of the notes to effectively increase the conversion price of
these notes and to reduce the potential dilution upon future conversion.
Conversion prices were effectively increased to $46.20 or a 65% premium and
$49.00 or a 75% premium for the 2011 and 2012 notes, respectively.
As of December 18, 2007, our Company did not have sufficient authorized shares
to provide for all potential issuances of common stock. Therefore, in accordance
with SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities", our Company accounted for the conversion features as freestanding
instruments. The notes were recorded with a discount equal to the value of the
conversion features at the transaction date and will be accreted to the par
value of the notes over the life of the notes. The value of the conversion
features were determined utilizing the Black-Scholes option pricing model and
recorded as a long term liability. The portion of the conversion features for
which there are not shares available for settlement of conversions is marked to
market each balance sheet date. During the 16 weeks ended June 14, 2008, the
gain that was recorded in "Nonoperating Income" on our Consolidated Statements
of Operations for the conversion features of the 5.125% and 6.75% convertible
senior notes was $11.1 million and $5.1 million, respectively. Based on an
increase in available shares primarily due to the exercise of our Series A
warrants, $3.6 million and $14.7 million for the conversion features of the
5.125% and 6.75% convertible senior notes, respectively, were reclassified to
"Additional paid-in-capital" on our Consolidated Statements of Stockholder's
Equity and Comprehensive (Loss) Income. The fair value of the conversion
features classified as a liability as of June 14, 2008 was $8.5 million and nil
for the 5.125% and 6.75% convertible notes, respectively. The following
assumptions and estimates were used in the Black-Scholes model:
For the 16 weeks
ended
June 14, 2008
---------------------
Expected life 3.0 years - 4.5 years
Volatility 33.0%
Dividend yield range 0%
Risk-free interest rate range 3.38% - 3.73%
Financing Warrants
------------------
Concurrent with the issuance of the convertible senior notes, our Company issued
financing warrants in conjunction with the call options recorded as equity in
the Consolidated Balance Sheet to effectively increase the conversion price of
these notes and reduce the potential dilution upon future conversion. The
financing warrants allow holders to purchase common shares at $46.20 with
respect to the 5.125% notes and $49.00 with respect to the 6.75% notes. The
financing warrants were valued at $36.8 million at the issuance date. At the
issuance date our Company did not have sufficient authorized shares to provide
all potential issuances of common stock. Therefore, the financing warrants are
accounted for as freestanding derivatives, required to be settled in cash until
sufficient shares are available and are recorded as a long-
25
term liability in the Consolidated Balance Sheet. The financing warrants are
marked to market each reporting period utilizing the Black-Scholes option
pricing model and are valued at $24.7 million as of June 14, 2008. During the 16
weeks ended June 14, 2008, we recorded a gain of $6.5 million included in
"Nonoperating income" on our Consolidated Statements of Operations. The
following assumptions and estimates were used in the Black-Scholes model:
For the 16 weeks
ended
June 14, 2008
---------------------
Expected life 3.3 years - 4.8 years
Volatility 33.0%
Dividend yield range 0%
Risk-free interest rate range 3.38% - 3.73%
11. Interest Expense
Interest expense is comprised of the following:
For the 16 Weeks Ended
---------------------------------
June 14, June 16,
2008 2007
--------------- ----------------
Credit Agreement $ 3,414 $ 910
7.75% Notes, due April 15, 2007 - 342
9.125% Senior Notes, due December 15, 2011 360 360
5.125% Convertible Senior Notes, due June 15, 2011 2,595 -
6.750% Convertible Senior Notes, due December 15, 2012 5,282 -
9.375% Notes, due August 1, 2039 5,753 5,753
Capital Lease Obligations and Real Estate Liabilities 17,079 10,240
Amortization of Deferred Financing Fees and Discounts 5,852 293
Other 5,614 1,815
----------- -----------
Total $ 45,949 $ 19,713
=========== ===========
12. 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. We use our
fiscal year end as the measurement date. The components of net pension cost were
as follows:
For the 16 Weeks Ended
--------------------------------
June 14, June 16,
2008 2007
----------- ---------
Service cost $ 1,534 $ 1,515
Interest cost 7,590 3,734
Expected return on plan assets (9,066) (4,041)
Amortization of unrecognized net prior service cost 74 79
Amortization of unrecognized net loss 36 30
Administrative expenses and other - -
-------- --------
Net pension cost $ 168 $ 1,317
======== ========
26
Contributions
We previously disclosed in our consolidated financial statements for the year
ended February 23, 2008, that we expected to contribute $4.5 million in cash to
our defined benefit plans in fiscal 2008. As of June 14, 2008, we contributed
approximately $2.2 million to our defined benefit plans. We plan to contribute
approximately $2.3 million to our plans during the remainder of fiscal 2008.
Postretirement Benefits
We provide postretirement health care and life insurance benefits to certain
union and non-union employees. We recognize the cost of providing postretirement
benefits during employees' active service periods. We use our fiscal year end as
the measurement date for our postretirement benefits. The components of net
postretirement benefits cost (income) were as follows:
For the 16 Weeks Ended
--------------------------------
June 14, June 16,
2008 2007
------------ -------------
Service cost $ 312 $ 100
Interest cost 705 324
Amortization of gain - (140)
Prior service credit (414) (415)
--------- ---------
Net postretirement benefits cost (income) $ 603 $ (131)
======== =========
13. Stock Based Compensation
During the first quarter of fiscal 2008, compensation expense related to
share-based incentive plans was $4.9 million, after tax, compared to $2.9
million, after tax, during the first quarter of fiscal 2007. Included in
share-based compensation expense recorded during the first quarter of fiscal
2008 and fiscal 2007 was $0.6 million and $0.2 million, respectively, related to
expensing of stock options, $4.1 million and $2.5 million, respectively,
relating to expensing of restricted stock, and $0.2 million and $0.2 million,
respectively, relating to expensing of common stock granted to our Board of
Directors at the Annual Meeting of Stockholders.
At June 14, 2008, we had two stock-based compensation plans, the 1998 Long Term
Incentive and Share Award Plan and the 2004 Non-Employee Director Compensation
Plan. The general terms of each plan are reported in our Fiscal 2007 Annual
Report on Form 10-K.
27
Stock options
-------------
The following is a summary of the stock option activity during the first quarter
ended June 14, 2008:
Weighted
Weighted Average
Average Remaining Aggregate
Exercise Contractual Intrinsic
Shares Price Term (years) Value
------------- ------------- ------------ -------------
Outstanding at February 23, 2008 1,827,529 $ 24.21
Granted 128,434 26.07
Canceled or expired (40,863) 30.74
Exercised (104,536) 20.81
-------------- ----------
Outstanding at June 14, 2008 1,810,564 $ 24.39 3.7 $ 7.3
============= ========== ============= =============
Exercisable at:
June 14, 2008 1,582,485 $ 23.88 3.0 $ 7.3
============= =============
Nonvested at:
June 14, 2008 228,079 $ 27.94 9.1 $ -
============= =============
Fair values for each stock option 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. Our stock options have a contractual term of 10 years. The following
assumptions were in place for grants that occurred during the 16 weeks ended
June 14, 2008 and June 16, 2007:
16 weeks ended 16 weeks ended
June 14, 2008 June 16, 2007
------------------ -----------------
Expected life 7 years 7 years
Volatility 52% 54% - 55%
Risk-free interest rate 2.96% 4.46% - 4.57%
The weighted average grant date fair value of stock options granted during the
first quarter ended June 14, 2008 and June 16, 2007 was $14.64 and $19.47,
respectively.
As of June 14, 2008, approximately $2.8 million, after tax, of total
unrecognized compensation expense related to unvested stock option awards will
be recognized over a weighted average period of 3.1 years.
The total intrinsic value of options exercised during the first quarter ended
June 14, 2008 and June 14, 2007 was $0.5 million and $4.9 million, respectively.
The amount of cash received from the exercise of stock options during the first
quarter of fiscal 2008 was approximately $2.2 million.
28
Performance Restricted Stock Units
----------------------------------
The following is a summary of the performance restricted stock units activity
during the first quarter ended June 14, 2008:
Weighted
Average
Grant Date
Shares Fair Value
-------------- --------------
Nonvested at February 23, 2008 1,905,427 $ 22.60
Granted 424,782 26.07
Canceled or expired (29,536) 27.32
Vested (435,600) 12.47
-------------- -------------
Nonvested at June 14, 2008 1,865,073 $ 25.68
============= =============
Performance restricted stock units are granted at the fair market value of the
Company's common stock at the date of grant, adjusted by an estimated forfeiture
rate.
During the first quarter of fiscal 2008, fifty percent of our performance
restricted units granted in fiscal 2005, vested on February 24, 2008 (the first
day of our fiscal year) and the remaining fifty percent will vest on the first
day of fiscal 2009, in accordance with and subject to all other terms,
conditions, limitations, restrictions and eligibility requirements. No units
vested under our 2006 and 2007 grants during the first quarter of fiscal 2008.
The total fair value of shares vested during the first quarter ended June 14,
2008 was $12.1 million. No shares vested during the first quarter ended June 16,
2007.
Performance restricted stock units issued during fiscal 2008 are earned based on
our Company achieving certain operating targets in fiscal 2010 and are 100%
vested in fiscal 2010, respectively, upon achievement of those targets.
During the first quarter of fiscal 2008 and fiscal 2007, our Company granted
424,782 shares and 488,746 shares of performance restricted stock units to
selected employees, respectively, for a total grant date fair value of $11.1
million and $16.2 million, respectively. Approximately $24.4 million of
unrecognized fair value compensation expense relating to these performance
restricted stock units, and those issued in the previous year are expected to be
recognized through fiscal 2011 based on estimates of attaining vesting criteria.
14. Income Taxes
The income tax provisions recorded for the 16 weeks ended June 14, 2008 and June
16, 2007 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 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 deferred tax asset to zero. For the 16 weeks
ended June 14, 2008, the valuation allowance increased by $46.2 million to
reflect the increase in deferred income tax assets
29
recorded relating to the purchase price allocation adjustment discussed in Note
3 - Acquisition of Pathmark Stores, Inc., as well as the generation of
additional net operating losses. For the 16 weeks ended June 16, 2007, the
valuation allowance decreased by $7.0 million. To the extent that our operations
generate sufficient taxable income in 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 losses
until such time as the certainty of future tax benefits can be reasonably
assured.
As of June 14, 2008, there have been no material changes to the Company's
uncertain tax positions disclosures as discussed in Note 11 of the Company's
Fiscal 2007 Annual Report on Form 10-K. The Company does not anticipate that
total unrecognized tax benefits will significantly change in the next 12 months.
For the 16 weeks ended June 14, 2008 and June 16, 2007, no amounts were recorded
for interest and penalties within "Provision for income taxes" in our
Consolidated Statements of Operations.
Our Company is subject to U.S. federal income tax, as well as income tax in
multiple state and foreign jurisdictions. As of June 14, 2008, we were subject
to examination in the U.S. federal tax jurisdiction for the 1997 to 2006 tax
years and we were also subject to examination in most state jurisdictions for
the 1997 to 2006 tax years as well.
The effective tax rate on continuing operations of 26.9% for the 16 weeks ended
June 14, 2008 varied from the statutory rate of 35% primarily due to the
recording of state and local income taxes, recording additional valuation
allowance offset by a permanent difference related to nonoperating income from
the fair value adjustments related to the conversion features, financing
warrants and Series B warrants.
The effective tax rate on continuing operations of 4.9% for the 16 weeks ended
June 16, 2007 varied from the statutory rate of 35% primarily due to the
recording of state and local income taxes and a reduction of our valuation
allowance as a result of taxes provided on other comprehensive income and
cumulative translation adjustments.
As of June 14, 2008 we had $406.0 million in federal NOL carryforwards that
expire beginning in 2023, some of which are subject to an annual limitation.
Management believes such limitations will not have a material impact on the
Company's ability to utilize such losses.
At June 14, 2008 and February 23, 2008, we had a net current deferred tax asset
which is included in "Prepaid expenses and other current assets" on our
Consolidated Balance Sheets of $54.4 million and $64.8 million, respectively, a
net non-current deferred tax asset which is included in "Other Assets" on our
Consolidated Balance Sheets of $48.4 million and $38.0 million, respectively,
and a non-current tax liability for uncertain tax positions which is included in
"Other non-current liabilities" on our Consolidated Balance Sheets of $156.3
million and $156.3 million, respectively.
15. 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.
30
In the fourth quarter of 2007, we acquired Pathmark and we revised our reporting
segments to be consistent with the manner in which our chief operating decision
maker currently manages the business. Accordingly during the first quarter ended
June 14, 2008, we operated under seven reportable segments: North, Central,
South, Pathmark, Gourmet, Other and our investment in Metro, Inc. The Other
segment includes our Food Basics and Liquor businesses. Our investment in Metro,
Inc. represents our economic interest in Metro, Inc. and is required to be
reported as an operating segment in accordance with SFAS No. 131, "Disclosure
about Segments of an Enterprise and Related Information" as our investment was
greater than 10% of our Company's combined assets of all operating segments and
the investment generated operating income during the first quarter of fiscal
2007. The criteria necessary to classify the Midwest and Greater New Orleans
areas as discontinued have been satisfied and these operations have been
reclassified as such in our Consolidated Statements of Operations for the 16
weeks ended June 14, 2008 and June 16, 2007. Refer to Note 8 - Discontinued
Operations for further discussion. Prior year information has been restated to
conform to current year presentation.
The accounting policies for these segments are the same as those described in
the summary of significant accounting policies included in our Fiscal 2007
Annual Report. We measure segment performance based upon segment income (loss).
Reconciling amounts between segment income (loss) and income (loss) from
operations include corporate-level activity not specifically attributed to a
segment, which includes 1) the purchase of all merchandise (including the design
and production of private label merchandise sold in our retail stores), 2) real
estate management and 3) information technology, finance and other corporate
administrative personnel, as well as, other reconciling items primarily
attributed to nonrecurring activities.
Assets and capital expenditures are not allocated to segments for internal
reporting presentations.
Interim information on segments is as follows:
For the 16 weeks ended June 14, 2008
-------------------------------------------------------------------------------------
Grocery (1) Meat (2) Produce (3) Other (4) Total
--------------- --------------- --------------- --------------- ---------------
Sales by Category $ 2,035,849 $ 549,755 $ 337,061 $ - $ 2,922,665
=============== ============== =============== ============== ===============
For the 16 weeks ended June 16, 2007
-------------------------------------------------------------------------------------
Grocery (1) Meat (2) Produce (3) Other (4) Total
--------------- --------------- --------------- --------------- ---------------
Sales by Category $ 1,116,336 $ 328,233 $ 229,845 $ 4,755 $ 1,679,169
=============== ============== =============== ============== ===============
(1) The grocery category includes grocery, frozen foods, dairy, general
merchandise/health and beauty aids, liquor and pharmacy.
(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.
31
For the 16 weeks ended
-------------------------------------------------
June 14, 2008 June 16, 2007
---------------------- ----------------------
Sales
North $ 596,220 $ 584,835
Central 407,241 432,793
South 496,916 500,794
Pathmark 1,254,195 -
Gourmet 94,479 88,183
Other 73,614 67,809
Investment in Metro, Inc. - 4,755
---------------------- ----------------------
Total sales $ 2,922,665 $ 1,679,169
====================== ======================
Segment income (loss)
North $ 28,571 $ 27,951
Central 5,879 6,549
South (3,689) (5,877)
Pathmark 25,734 -
Gourmet 7,709 5,728
Other 446 (1,301)
---------------------- ----------------------
Total segment income 64,650 33,050
Corporate (48,463) (41,319)
Reconciling items * (14,096) 1,895
---------------------- ----------------------
Income (loss) from operations 2,091 (6,374)
Loss on sale of Canadian operations - (281)
Gain on sale of Metro, Inc. - 78,388
Nonoperating income 48,597 -
Interest expense (45,949) (19,713)
Interest and dividend income 410 4,666
Equity earnings in Metro, Inc. - 7,869
---------------------- ----------------------
Income from continuing operations before income taxes $ 5,149 $ 64,555
====================== ======================
For the 16 weeks ended
-------------------------------------------------
June 14, 2008 June 16, 2007
---------------------- ----------------------
Segment depreciation and amortization - continuing operations
North $ 11,000 $ 11,451
Central 8,688 9,317
South 9,526 10,558
Pathmark 29,379 -
Gourmet 3,404 3,187
Other 1,129 1,304
---------------------- ----------------------
Total segment depreciation and amortization - continuing 63,126 35,817
operations
Corporate 16,901 11,895
---------------------- ----------------------
Total depreciation and amortization - continuing operations 80,027 47,712
Discontinued operations - 8,637
---------------------- ----------------------
Total company depreciation and amortization $ 80,027 $ 56,349
====================== ======================
* Reconciling items which are not included in segment income (loss) include LIFO
reserve adjustment, stock awards expense, restructuring events, real-estate
related activity, integration costs and other nonrecurring adjustments.
32
16. Investment in Metro, Inc.
On March 13, 2007, in connection with our agreement to acquire Pathmark Stores,
Inc., our Company sold 6,350,000 shares of our holdings in Metro, Inc. for
proceeds of approximately $203.5 million resulting in a net gain of $78.4
million. Of the proceeds received, $190 million was held as restricted cash
collateralizing letters of credit under our Letter of Credit Agreement and was
designated to be used to fund a portion of our acquisition of Pathmark Stores,
Inc.
On November 26, 2007, also in connection with our agreement to acquire Pathmark
Stores, Inc., our Company sold the remaining 11,726,645 shares of our holdings
in Metro, Inc. for proceeds of approximately $345.3 million, resulting in a net
gain of $103.6 million. The proceeds were held to fund a portion of our
acquisition of Pathmark Stores, Inc. As a result of these sales, our Company no
longer holds Class A subordinate shares of Metro, Inc. as our investment has
been fully liquidated as of the balance sheet date.
Through March 13, 2007, we recorded our pro-rata equity earnings 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 16, 2007, 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. In accordance with SFAS 115, we recorded dividend
income of $1.3 million based on Metro, Inc.'s dividend declaration on April 17,
2007 and included this amount in "Interest and dividend income" on our
Consolidated Statements of Operations for the first quarter ended June 16, 2007.
Metro, Inc.'s summarized financial information, derived from its unaudited
second quarter ended March 17, 2007 financial statements, is as follows (in
millions):
12 Weeks Ended
March 17, 2007
--------------
Income statement:
Net sales $ 2,096.5
=============
Cost of sales and operating expenses $ 1,967.1
=============
Net income $ 55.0
=============
17. Commitments and Contingencies
Lease Assignment
----------------
On August 14, 2007, Pathmark entered into a leasehold assignment contract for
the sale of its leasehold interests in one of its stores to CPS Operating
Company LLC, a Delaware limited liability company ("CPS"). Pursuant to the terms
of the agreement, Pathmark was to receive $87 million for assigning and
transferring to CPS all of Pathmark's interest in the lease and CPS was to have
assumed all of the duties and obligations of Pathmark under the lease. CPS
deposited $6 million in escrow as a deposit against the purchase price for the
lease, which is non-refundable to CPS, except as otherwise expressly provided in
the agreement. The assignment of the lease was scheduled to close on December
28, 2007. On December 27, 2007, CPS issued a notice terminating the agreement
for reason of a purported breach of the agreement, which, if proven, would
require the return of the escrow. We are disputing the validity of CPS's notice
of termination as we believe CPS's position is without merit. Because we are
challenging the validity of CPS's December 27, 2007 notice of termination, we
issued our own notice to CPS on December 31, 2007, asserting CPS's breach of the
agreement as a result of their failure to close on December 28, 2007. CPS's
33
breach, if proven, would entitle us to keep the escrow. Both parties have taken
legal action to obtain the $6 million deposit held in escrow.
LaMarca et al v. The Great Atlantic & Pacific Tea Company, Inc ("Defendants")
-----------------------------------------------------------------------------
On June 24, 2004, a class action complaint was filed in the Supreme Court of the
State of New York against The Great Atlantic & Pacific Tea Company, Inc., d/b/a
A&P, The Food Emporium, and Waldbaum's alleging violations of the overtime
provisions of the New York Labor Law. Three named plaintiffs, Benedetto Lamarca,
Dolores Guiddy, and Stephen Tedesco, alleged on behalf of a class that our
Company failed to pay overtime wages to full-time hourly employees who were
either required or permitted to work more than 40 hours per week.
In April 2006, the plaintiffs filed a motion for class certification. In July
2007, the Court granted the plaintiffs' motion and certified the class as
follows: All full-time hourly employees of Defendants who were employed in
Defendants' supermarket stores located in the State of New York, for any of the
period from June 24, 1998 through the date of the commencement of the action,
whom Defendants required or permitted to perform work in excess of 40 hours per
week without being paid overtime wages. The Court also ruled that the issue of
whether to include an "opt-in" or "opt-out" provision is premature and can be
decided after discovery has been had.
As discovery on the prospective plaintiffs comprising the class has yet to be
conducted, neither the number of class participants nor the sufficiency of their
respective claims can be determined at this time.
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.
34
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 2008 and fiscal 2007.
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 2008 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 14, 2008 compared to the
16 weeks ended June 16, 2007; current and expected future liquidity; and
the impact of various market risks on our Company.
o Critical Accounting Estimates -- a discussion of significant estimates made
by Management.
o Market Risk - a discussion of the impact of market changes on our
consolidated financial statements.
BASIS OF PRESENTATION
---------------------
The accompanying consolidated financial statements of The Great Atlantic &
Pacific Tea Company, Inc. for the 16 weeks ended June 14, 2008 and June 16, 2007
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 2007 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 and
all subsidiaries.
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 8 U.S. states and the District of Columbia. Our
Company's business consists strictly of our retail operations, which totaled 446
stores as of June 14, 2008.
For the 16 weeks ended June 14, 2008, we operated in seven reportable segments:
North, Central, South, Pathmark, Gourmet, Other and our investment in Metro,
Inc. The Other segment includes our Discount and Liquor businesses. Our
investment in Metro, Inc. represents our economic interest in Metro, Inc. The
criteria necessary to classify the Midwest and Greater New Orleans area as
discontinued were satisfied in
35
fiscal 2007 and these operations have been reclassified as such in our
Consolidated Statements of Operations for the 16 weeks ended June 14, 2008 and
June 16, 2007.
RECENT ANNOUNCEMENTS
--------------------
On March 7, 2008, our Company entered into a definitive agreement with C&S
Wholesale Grocers, Inc. ("C&S") whereby C&S will provide warehousing, logistics,
procurement and purchasing services (the "Services") in support of the Company's
entire supply chain. This agreement replaces and supersedes three (3) separate
wholesale supply agreements under which the parties have been operating. The
term of the agreement is ten and one-half (10-1/2) years, which includes a
six-month "ramp-up" period during which the parties will transition to the new
contractual terms and conditions. The agreement provides that the actual costs
of performing the services shall be reimbursed to C&S on an "open-book" or
"cost-plus" basis, whereby the parties will negotiate annual budgets that will
be reconciled against actual costs on a periodic basis. The parties will also
annually negotiate services specifications and performance standards that will
govern warehouse operations. The agreement defines the parties' respective
responsibilities for the procurement and purchase of merchandise intended for
use or resale at the Company's stores, as well as the parties' respective
remuneration for warehousing and procurement/purchasing activities. In
consideration for the services it provides under the agreement, C&S will be paid
an annual fee and will have incentive income opportunities based upon A&P's cost
savings and increases in retail sales volume.
On May 7, 2008, the 4,657,378 Series A warrants, scheduled to expire on June 9,
2008, were exercised by Yucaipa Corporate Initiatives Fund I, L.P., Yucaipa
American Alliance Fund I, L.P. and Yucaipa American Alliance (Parallel) Fund I,
L.P. Our Company opted to settle the Series A warrants in cash totaling $45.7
million rather than issuing additional common shares.
OPERATING RESULTS
-----------------
A&P's transformation and operating improvement continued moving forward in the
first quarter of fiscal 2008. In addition, ongoing strategic, operating,
merchandising, store development and cost control initiatives remained underway.
Our Company concentrated on effectively completing the comprehensive Pathmark
integration plan, as many of the milestones set thus far were achieved. The
integration provides our Company with the lead market share position in the
Northeast, while also significantly increasing the combined Company's share in
the greater Philadelphia area. Additionally, events to achieve a significant
portion of the anticipated $150 million integration synergies have been
finalized.
In late June, our Company announced another critical phase in our strategic
transformation mission. As part of our long-standing commitment to improve
market share, sales and sustainable profitability, the majority of SuperFresh
store locations in the Philadelphia market will be converted to the recently
premiered Price Impact format under the Pathmark Sav-A-Center banner. These
conversions will take place over the next year and focus on providing customers
with an improved value proposition and a one-stop-shopping experience. As such,
the majority of the format conversions in this area will be to the new Pathmark
Sav-A-Center Price Impact format. Further, the existing Pathmark stores in this
market will also be upgraded to the new Price Impact format. A number of
SuperFresh locations will remain and retain the Fresh format with significant
upgrades.
With integration of Pathmark completed and conversion plans underway in the
Greater Philadelphia market, A&P now has:
36
o Decisive market share leadership in metropolitan New York and New
Jersey, and an improved outlook for the greater share in our
Philadelphia markets.
o A comprehensive plan in place to achieve all identified synergy
savings through consolidation of the Pathmark business.
o An improved cost model and solid financial and investment platform.
Alongside the conclusion of the strategic transformation, we maintained the
ongoing improvement of operating and merchandising execution, which combined
with the growing impact of our new Fresh remodels, to drive continued, strong
year-over-year sales improvement in our Company's Northeast operations.
Accordingly, ongoing improvement from core operations was driven by the
continued sales improvement in those markets, more consistent operating
discipline and cost controls, and positive results in our Discount operations.
During the first quarter, we completed the remodel of A&P Fresh in Holmdel, New
Jersey to the updated Fresh format, and began remodeling additional stores. We
continue to experience increased volume and customer traffic in our remodeled
stores, especially in our Fresh categories.
Our Company also debuted the new Price Impact format in our Irvington and Edison
Pathmark's with much positive feedback. Both stores have shown significant
increased sales and customer traffic.
The Discount operations again returned sound results, as they provided customers
in certain markets with an excellent value alternative. In combination with the
mainstream Fresh stores and Gourmet concept that continued to evolve in New
York, this development stream continues to advance the multi-tier marketing
strategy initiated in 2005.
In summary, strategic accomplishments for the last quarter include the
following:
o Debuted the new Price Impact format in two Pathmark locations
o Completed one Fresh remodel
o Continued strong sales trends in core Northeast operating markets
o Maintained earnings momentum in our Northeast operations
o Improved Pathmark sales trends
o Improved contribution from Discount and Gourmet operations.
o Completed comprehensive Pathmark integration strategy
OUTLOOK
-------
Management's objectives for the remainder of fiscal 2008 are to progress further
toward operating profitability in the existing core Northeast business by:
continuing operating and merchandising
37
improvements behind established strategies; maintaining cost control and
reduction disciplines throughout the business; and ensuring the continuity of
Pathmark store operations, with emphasis on customer communication and
retention.
Chief among the pre-existing corporate and retail strategies in place are the
ongoing improvement of merchandising and operating performance, the execution of
capital improvement projects for maximum return, and general adherence to cost
control disciplines.
Key elements are:
o Continue development of merchandising, promotion and pricing
strategies to drive profitable sales growth.
o Execute core market capital plan for conversion of conventional
locations to fresh, price impact or discount formats, continue to
drive gourmet format development.
o Ongoing disposition of closed store leaseholds.
The comprehensive plan for the integration of Pathmark operations is designed to
achieve:
o Continuity of all retail operations during integration process.
o Effective execution of the new price impact format in designated
locations.
o Achievement of significant synergies identified as result of merging
the two businesses.
o Consumer communication regarding the continuation of both the
A&P-operated and Pathmark banners and store formats, and related
marketing and promotional efforts.
Overall, we will continue to reflect both continuity and change, as management
focuses on sustaining the improvement of our operations - and executing a
seamless transition of Pathmark operations into the Company, to maintain retail
continuity and ensure the capture of all identified financial synergies as
scheduled within the first 18 to 24 months of the acquisition.
Various factors could cause us to fail to achieve these goals. These include,
among others, the following:
o Our retail food business and the grocery retailing industry continues to
experience fierce competition from mass merchandisers, warehouse clubs,
drug stores, convenience stores, discount merchandisers, dollar stores,
restaurants, other retail chains, nontraditional competitors and emerging
alternative formats in the markets where we have retail operations.
Competition with these outlets is based on price, store location,
advertising and promotion, product mix, quality and service. Some of these
competitors may have greater financial resources, lower merchandise
acquisition costs and lower operating expenses than we do, and we may be
unable to compete successfully in the future. Price-based competition has
also, from time to time, adversely affected our operating margins.
Competitors' greater financial strengths enable them to participate in
aggressive pricing strategies selling inventory below costs to drive
overall increased sales. 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
38
generally and particularly in our principal markets may cause us to reduce
our prices in order to gain or maintain our market share of sales, thus
reducing margins.
o Our in-store pharmacy business is also subject to intense competition. In
particular, an adverse trend for drug retailing has been significant growth
in mail-order and internet-based prescription processors. Pharmacies are
exposed to risks inherent in the packaging and distribution of
pharmaceuticals and other healthcare products. In addition, the conversion
of various prescription drugs to over-the-counter medications, the
withdrawal of certain drugs from the market and changes in third party
reimbursement levels for prescription drugs, including changes in Medicare
Part D or state Medicaid programs, may have a material adverse effect on
our business. Failure to properly adhere to Federal, State and local
government rules and regulations, applicable Medicare and Medicaid
regulations could result in the imposition of civil as well as criminal
penalties.
o The retail food and food distribution industries, and the operation of our
businesses, specifically in the New York -- New Jersey and Philadelphia
regions, are sensitive to a number of economic conditions and other factors
such as (i.) food price deflation or inflation, (ii.) softness in local and
national economies, (iii.) increases in commodity prices, (iv.) the
availability of favorable credit and trade terms, (v.) changes in business
plans, operations, results and prospects, (vi.) potential delays in the
development, construction or start-up of planned projects, and (vii.) other
economic conditions that may affect consumer buying habits. Any one or more
of these economic conditions can affect our retail sales, the demand for
products we distribute to our retail customers, our operating costs and
other aspects of our business.
o Acts of war, threats of terror, acts of terror or other criminal activity
directed at the grocery or drug store industry, the transportation
industry, or computer or communications systems, could increase security
costs, adversely affect our operations, or impact consumer behavior and
spending as well as customer orders. Other events that give rise to actual
or potential food contamination, drug contamination, or food-borne illness
could have an adverse effect on our operating results.
o We could be adversely affected if consumers lose confidence in the safety
and quality of the food supply chain. Adverse publicity about these types
of concerns, whether or not valid, could discourage consumers from buying
products in our stores. The real or perceived sale of contaminated food
products by us could result in a loss of consumer confidence and product
liability claims, which could have a material adverse effect on our sales
and operations.
o Our operations subject us to various laws and regulations relating to the
protection of the environment, including those governing the management and
disposal of hazardous materials and the cleanup of contaminated sites.
Under some environmental laws, such as the Comprehensive Environmental
Response, Compensation, and Liability Act of 1980, also known as CERCLA or
the Superfund law, and similar state statues, responsibility for the entire
cost of cleanup of a contaminated site can be imposed upon any current or
former site owners or operators, or upon any party who sent waste to the
site, regardless of the lawfulness of the original activities that led to
the contamination. From time to time we have been named as one of many
potentially responsible parties at Superfund sites, although our share of
liability has typically been de minimis. Although we believe that we are
currently in substantial compliance with applicable environmental
requirements, future developments such as more aggressive enforcement
policies, new laws or discoveries of unknown conditions may require
expenditures that may have a material adverse effect on our business and
financial condition.
39
o Our capital expenditures could differ from our estimate if development and
remodel costs vary from those budgeted, or if performance varies
significantly from expectations or if we are unsuccessful in acquiring
suitable sites for new stores.
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
reduce 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 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 majority 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 reasonable 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.
o The success of the merger with Pathmark will depend, in part, on the
combined company's ability to realize the anticipated benefits from
combining the businesses of A&P and Pathmark, including, anticipated annual
integration synergies within two years, through cost reductions in
overhead, greater efficiencies, increased utilization of support facilities
and the adoption of mutual best practices between the two companies. These
integration matters could have a material adverse effect on our business.
o Following the closing of the acquisition of Pathmark, Tengelmann, A&P's
former majority stockholder, owned beneficially and of record a substantial
percentage of our common stock on a fully diluted basis. As a result of
this equity ownership and our stockholder agreement with Tengelmann,
Tengelmann has the power to significantly influence the results of
stockholder votes and the election of our board of directors, as well as
transactions involving a potential change of control of our Company.
Tengelmann may support strategies and directions for our Company which are
in its best interests but which are opposed to other stockholder interests.
40
o Our substantial indebtedness could impair our financial condition and our
ability to fulfill our debt obligations. Our indebtedness could make it
more difficult for us to satisfy our obligations, which could in turn
result in an event of default on our obligations, require us to dedicate a
substantial portion of our cash flow from operations to debt service
payments, thereby reducing the availability of cash for working capital,
capital expenditures, acquisitions, general corporate purposes or other
purposes, impair our ability to obtain additional financing in the future
for working capital, capital expenditures, acquisitions, general corporate
purposes or other purposes, diminish our ability to withstand a downturn in
our business, the industry in which we operate or the economy generally,
limit our flexibility in planning for, or reacting to, changes in our
business and the industry in which we operate, and place us at a
competitive disadvantage compared to certain competitors that have
proportionately less debt. Our New Credit Agreement ("Credit Agreement")
contains restrictive covenants customary for facilities of that type which
limit our ability to incur additional debt, pay dividends, grant additional
liens, make investments and take other actions. These restrictions may
limit our flexibility to undertake future financings and take other
actions. If we are unable to meet our debt service obligations, we could be
forced to restructure or refinance our indebtedness, seek additional equity
capital or sell assets. We may be unable to obtain financing or sell assets
on satisfactory terms, or at all. In addition, our Credit Agreement bears
interest at a variable rate. If market interest rates increase, such
variable-rate debt will have higher debt service requirements, which could
adversely affect our cash flow. While we may enter into agreements limiting
our exposure to higher interest rates, any such agreements may not offer
complete protection from this risk.
o We are the primary obligor for a significant amount of closed stores and
warehouses under long-term leases. Our ability to sublet or assign these
leases depends on the economic conditions of the real estate markets in
which these leases are located. We have estimated our obligation under
these leases, net of expected subleases and we have reserved for them,
where appropriate. Unexpected changes in the marketplace or with individual
sublessors could result in an adverse effect on our cash flow and earnings.
o Fluctuating fuel costs may adversely affect our operating costs since we
incur the cost of fuel in connection with the transportation of goods from
our warehouse and distribution facilities to our stores. In addition,
operations at our stores are sensitive to rising utility fuel costs due to
the amount of electricity and gas required to operate our stores. We may
not be able to recover these rising utility and fuel costs through
increased prices charged to our customers. Our profitability is
particularly sensitive to the cost of oil. Oil prices directly affect our
product transportation costs and fuel costs due to the amount of
electricity and gas required to operate our stores as well as our utility
and petroleum-based supply costs; including plastic bags for example.
41
o We are subject to federal, state and local laws and regulations relating to
zoning, land use, environmental protection, work place safety, public
health, community right-to-know, beer and wine sales, pharmaceutical sales
and gasoline station operations. A number of states and local jurisdictions
regulate the licensing of supermarkets, including beer and wine license
grants. In addition, under certain local regulations, we are prohibited
from selling beer and wine in certain of our stores. Employers are also
subject to laws governing their relationship with employees, including
minimum wage requirements, overtime, working conditions, disabled access
and work permit requirements. Compliance with these laws could reduce the
revenue and profitability of our supermarkets and could otherwise adversely
affect our business, financial condition or results of operations. In
addition, any changes in these laws or regulations could significantly
increase our compliance costs and adversely affect our results of
operations, financial condition and liquidity.
o We have large, complex information technology systems that are important to
business operations. We could encounter difficulties developing new systems
and encounter difficulties maintaining, upgrading or securing our existing
systems. Such difficulties could lead to significant expenses or losses due
to disruption in our business operations.
o Our articles of incorporation permit our board of directors to issue
preferred shares without first obtaining stockholder approval. If we issued
preferred shares, these additional securities may have dividend or
liquidation preferences senior to our common stock. If we issue convertible
preferred shares, a subsequent conversion may dilute the current common
stockholders' interest. Issuance of such preferred stock could adversely
affect the price of our common stock.
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 results 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. All amounts are in millions, except share and per share
amounts.
16 WEEKS ENDED JUNE 14, 2008 COMPARED TO THE 16 WEEKS ENDED JUNE 16, 2007
-------------------------------------------------------------------------
OVERALL
-------
Sales for the first quarter of fiscal 2008 were $2,922.7 million, compared with
$1,679.2 million in the first quarter of fiscal 2007 due primarily to the
acquisition of Pathmark; comparable store sales, which includes stores that have
been in operation for two full fiscal years and replacement stores, increased
3.2%. Income from continuing operations decreased from $61.4 million for the
first quarter of fiscal 2007 to $3.8 million for the first quarter of fiscal
2008 primarily due to the absence of the gain on sale of Metro, Inc. of $78.4
million. Loss from discontinued operations of $126.5 million for the first
quarter of fiscal 2007 decreased to a loss from discontinued operations of $1.5
million for the first quarter of fiscal 2008 due to the absence of the sale and
closure of stores in the Midwest and the sale of our stores in the Greater New
Orleans area. Net income per share - basic for the first quarter of fiscal 2008
was $0.05 and net loss per share - diluted for the first quarter of fiscal 2008
was $0.51, compared to net loss per share - basic & diluted of $1.56 and $1.54,
respectively, for the first quarter of fiscal 2007.
42
16 Weeks 16 Weeks
Ended Ended Favorable
June 14, 2008 June 16, 2007 (Unfavorable) % Change
--------------- --------------- --------------- ----------
Sales $ 2,922.7 $ 1,679.2 $ 1,243.5 74.1%
Increase in comparable store sales 3.2% 1.0% NA NA
Income from continuing operations 3.8 61.4 (57.6) (93.8%)
Loss from discontinued operations (1.5) (126.5) 125.0 98.8%
Net income (loss) 2.2 (65.1) 67.3 >100.0%
Net income (loss) per share - basic 0.05 (1.56) 1.61 >100.0%
Net loss per share - diluted (0.51) (1.54) 1.03 66.9%
Average weekly sales per supermarket were approximately $429,900 for the first
quarter of fiscal 2008 versus $348,700 for the corresponding period of the prior
year, an increase of 23.3% primarily due to the acquisition of Pathmark's larger
supermarkets in the fourth quarter of fiscal 2007.
SALES
-----
For the 16 weeks ended
----------------------------------
June 14, 2008 June 16, 2007
-------------- ----------------
North $ 596,220 $ 584,835
Central 407,241 432,793
South 496,916 500,794
Pathmark 1,254,195 -
Gourmet 94,479 88,183
Other 73,614 67,809
Investment in Metro, Inc. - 4,755
--------------- --------------
Total sales $ 2,922,665 $ 1,679,169
=============== ==============
Sales increased from $1,679.2 million for the 16 weeks ended June 16, 2007 to
$2,922.7 million for the 16 weeks ended June 14, 2008 primarily due to the
acquisition of Pathmark in the fourth quarter of fiscal 2007 contributing
$1,254.2 million in sales as well as an increase in comparable stores sales of
$48.1 million, offset by the absence of sales from store closures of $64.8
million. The increases in sales in our North and Gourmet segments of $11.4
million and $6.3 million, respectively, are primarily due to comparable store
sales increases. Central sales decreased $25.6 million or 5.9% as a result of
store closures from the beginning of the second quarter of fiscal 2007 through
the first quarter of fiscal 2008. Sales in our South segment decreased by $3.9
million or 0.8%, which is primarily the result of store closures. The sales
increase of $5.8 million, or 8.6%, in our Other segment, representing Discount
and Liquor, is primarily due to an increase in comparable store sales driven by
our remodel program and our acquisition of Best Cellars, offset partially by
store closures. The decrease in sales of $4.8 million, or 100%, in our Metro
Segment is due to the expiration of our information technology agreement with
Metro, Inc. during fiscal 2007.
GROSS MARGIN
------------
Gross margin of $883.6 million decreased 92 basis points as a percentage of
sales to 30.23% for the first quarter of fiscal 2008 from gross margin of $523.0
million or 31.15% for the first quarter of fiscal 2007 driven primarily by the
inclusion of Pathmark in the first quarter of fiscal 2008 (64 basis points) and
the expiration of our information technology agreement with Metro, Inc. (28
basis points.) Before considering the impact of the Pathmark acquisition, we
achieved gross margin of $515.4 million or 30.89% as a
43
percentage of sales in the first quarter of fiscal 2008 which is comparable to
results from the first quarter of fiscal 2007, excluding the margin related to
our information technology agreement with Metro, Inc.
The following table details the dollar impact of items affecting the gross
margin dollar increase (decrease) from the first quarter of fiscal 2007 to the
first quarter of fiscal 2008 (in millions):
Sales Volume Gross Margin Rate Total
---------------- ----------------- ---------------
Total Company $ 387.3 $ (26.7) $ 360.6
STORE OPERATING, GENERAL AND ADMINISTRATIVE EXPENSE
---------------------------------------------------
The following table presents store operating, general and administrative expense
("SG&A"), in dollars and as a percentage of sales for the 16 weeks ended June
14, 2008 compared to the 16 weeks ended June 16, 2007. SG&A expense was $881.5
million or 30.16% for the first quarter of fiscal 2008 as compared to $529.4
million or 31.52% for the first quarter of fiscal 2007. The increase in SG&A was
primarily related to the acquisition of Pathmark of $340.9 million.
Included in SG&A for the first quarter of fiscal 2008 were certain charges as
follows:
o net losses on real estate activity of $1.1 million (4 basis points); and
o Pathmark acquisition related costs of $14.0 million (48 basis points).
Partially offset by:
o Reversal of net restructuring activity of $0.2 million (1 basis point).
Included in SG&A for the first quarter of fiscal 2007 were certain charges as
follows:
o costs relating to the closing of our owned warehouses in Edison, New Jersey
and Bronx, New York of $0.8 million (5 basis points) that were not 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
9 - Asset Disposition Initiatives;
o net losses on real estate activity of $2.2 million (14 basis points); and
o Pathmark acquisition related costs of $0.4 million (3 basis points).
Excluding the items listed above, SG&A as a percentage of sales decreased by 171
basis points during the first quarter of fiscal 2008 as compared to the first
quarter of fiscal 2007 primarily due to the acquisition of Pathmark which
contributed higher sales productivity.
During the 16 weeks ended June 14, 2008 and June 16, 2007, we recorded
impairment losses on long-lived assets for impairments due to closure or
conversion of stores in the normal course of business of $0.8 million and $0.5
million, respectively.
The effects of changes in estimates of useful lives were not material to ongoing
depreciation expense. If current operating levels do not improve, there may be a
need to take further actions which may result in additional future impairments
on long-lived assets, including the potential for impairment of assets that are
held and used.
44
SEGMENT INCOME
--------------
For the 16 weeks ended
-----------------------------------
June 14, 2008 June 16, 2007
-------------- --------------
North $ 28,571 $ 27,951
Central 5,879 6,549
South (3,689) (5,877)
Pathmark 25,734 --
Gourmet 7,709 5,728
Other 446 (1,301)
------------ -----------
Total segment income $ 64,650 $ 33,050
============ ===========
Segment income increased $31.6 million from $33.1 million for the 16 weeks ended
June 16, 2007 to $64.7 million for the 16 weeks ended June 14, 2008. First
quarter of fiscal 2008 results include segment income of $25.7 million from the
Pathmark business acquired in the fourth quarter of fiscal 2007. Our North
segment experienced an increase in segment income of $0.6 million from a
combination of increased sales of $11.4 million and decreased costs, mainly in
labor and administration. Segment income declined $0.7 million in our Central
segment as a result of a decrease in sales of $25.6 million due to the
divestiture of 5 stores in fiscal 2007. Our South segment results improved from
a Segment loss of $5.9 million during the first quarter of fiscal 2007 to a loss
of $3.7 million in the fourth quarter of fiscal 2008. This improvement is
primarily due to the closure of certain under performing stores. Segment income
from our Gourmet business improved by $2.0 million primarily as a result of an
improved gross margin rate partially offset by additional operating and
administrative costs. The increase in segment income of $1.7 million in our
Other segment, representing Discount and Liquor, is primarily due to improving
sales and margin rates in both businesses. Refer to Note 15 - Operating Segments
for further discussion of our reportable operating segments.
GAIN ON SALE OF METRO, INC.
---------------------------
During the first quarter of fiscal 2007, we sold 6,350,000 shares of our holding
in Metro, Inc. resulting in a gain of $78.4 million. There were no such gains
during the first quarter of fiscal 2008.
INTEREST EXPENSE
----------------
Interest expense of $45.9 million for the first quarter of fiscal 2008 increased
from the prior year of $19.7 million due primarily to the higher level of
indebtedness related to our acquisition of Pathmark including the issuance of
$165 million 5.125% convertible senior notes due 2011 and $255 million 6.75%
convertible senior notes due 2012 resulting in an increase in interest expense
of $11.6 million ($3.7 million of which were non-cash costs), increased
borrowings on our Line of Credit and Credit Agreement of $5.7 million and an
increase in interest expense related to Pathmark of $7.4 million primarily due
to interest on capital leases.
NONOPERATING INCOME
-------------------
During the first quarter of fiscal 2008, we recorded $48.6 million in fair value
adjustments for (i.) our Series A and Series B warrants acquired in connection
with our purchase of Pathmark, (ii.) our conversion feature of the 5.125%
convertible senior notes and the 6.75% convertible senior notes, and (iii.) our
financing warrants recorded in connection with the issuance of our convertible
senior notes. There were no such gains during the first quarter of fiscal 2007.
45
EQUITY IN EARNINGS OF METRO, INC.
---------------------------------
We used the equity method of accounting to account for our investment in Metro,
Inc., through March 13, 2007, because we exerted 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. During the 16 weeks ended June
16, 2007, we recorded $7.9 million in equity earnings relating to our equity
investment in Metro, Inc.
During fiscal 2007, we sold all of our holdings in Metro, Inc. Thus, there were
no such equity earnings during the first quarter ended June 14, 2008.
INCOME TAXES
------------
The provision for income taxes from continuing operations for the first quarter
of fiscal 2008 was $1.4 million compared to $3.1 million for the first quarter
of fiscal 2007. Consistent with prior year, we continue to record a valuation
allowance against our net deferred tax assets.
The effective tax rate on continuing operations of 26.9% for the 16 weeks ended
June 14, 2008 varied from the statutory rate of 35% primarily due to the
recording of state and local income taxes, recording additional valuation
allowance offset by a permanent difference related to nonoperating income from
the fair value adjustments related to the conversion features, financing
warrants and Series B warrants.
The effective tax rate on continuing operations of 4.9% for the 16 weeks ended
June 16, 2007 varied from the statutory rate of 35% primarily due to the
recording of state and local income taxes and a reduction of our valuation
allowance as a result of taxes provided on other comprehensive income and
cumulative translation adjustments.
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. However, our Company continues to
pay occupancy costs for operating leases on closed locations.
On April 24, 2007, based upon unsatisfactory operating trends and the need to
devote resources to our expanding Northeast core business, our Company announced
negotiations for the sale of our non-core stores within our Midwest operations,
including inventory related to these stores. Our Company ceased sales operations
in all stores as of July 7, 2007. Planned sale transactions for these stores
have been completed.
On May 30, 2007, our Company announced advanced negotiation for the sale of our
non-core stores located within the Greater New Orleans area, including inventory
related to these stores. Our Company ceased sales operations in all stores not
sold as of November 1, 2007. Planned sale transactions for these stores have
been completed.
The loss from operations of discontinued businesses, net of tax, for the first
quarter of fiscal 2008 of $4.2 million decreased from a loss from operations of
discontinued businesses, net of tax, of $79.8 million for the first quarter of
fiscal 2007 primarily due to a decrease in vacancy related costs that were
recorded in the first quarter of fiscal 2007 due to the closure of stores in the
Midwest and the Greater New Orleans area. The gain on disposal of discontinued
operations, net of tax, for the first quarter of fiscal 2008 of $2.6 million
relates to
46
the sale of our Eight O'Clock Coffee business in fiscal 2003. This gain was a
result of the settlement of a contingent note and the value and payment was
based upon certain elements of the future performance of the Eight O'Clock
Coffee business and was not originally recorded in the gain during fiscal 2003.
The loss on disposal of discontinued operations, net of tax, for the first
quarter of fiscal 2007 of $46.8 million is primarily due to impairment losses
recorded on the property, plant and equipment in the Midwest and the Greater New
Orleans area as we recorded the assets' fair market value based upon the
proceeds received less costs to sell.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
CASH FLOWS
----------
The following table presents excerpts from our Consolidated Statement of Cash
Flows:
16 weeks ended
-------------------------------------------
June 14, 2008 June 16, 2007
----------------- -----------------
Net cash (used in) provided by operating activities $ (5,415) $ 27,631
----------------- -----------------
Net cash (used in) provided by investing activities $ (25,670) $ 32,900
----------------- -----------------
Net cash provided by (used in) by financing activities $ 59,409 $ (52,530)
----------------- -----------------
Net cash used in operating activities of $5.4 million for the 16 weeks ended
June 14, 2008 primarily reflected our net income of $2.2 million, adjusted for
non-cash charges for (i.) depreciation and amortization of $80.0 million, (ii.)
other share based awards of $4.8 million, partially offset by, (iii.) the
reversal of charges related to our asset disposition initiatives of $1.8
million, (iv.) gain on disposal of discontinued operations of $2.6 million, and
(v.) nonoperating income related to marked to market adjustments for financial
instruments of $48.6 million. Further, cash was provided by an increase in
accounts payable of $47.0 million mainly due to the timing of payments partially
offset by a decrease in prepaid expenses and other current assets of $14.7
million, an increase in other assets of $6.4 million, a decrease in accrued
salaries, wages and benefits, and taxes of $27.6 million, a decrease in other
non-current liabilities of $35.9 million primarily due to payments on closed
locations. Refer to Working Capital below for discussion of changes in working
capital items. Net cash provided by operating activities of $27.6 million for
the 16 weeks ended June 16, 2007 primarily reflected our net loss of $65.1
million, adjusted for non-cash charges for (i.) depreciation and amortization of
$56.3 million, and (ii.) losses on the disposal of owned property of $1.2
million, (iii.) loss on disposal of discontinued operations, primarily related
to our Midwest operations, of $46.8 million, partially offset by (iv.) our
equity in earnings of Metro, Inc. of $7.9 million, and (v.) the gain on sale of
shares of Metro, Inc. of $78.4 million. Further, cash was provided by a decrease
in accounts receivable of $27.9 million, a decrease in inventories of $29.0
million partially offset by an increase in prepaid expenses and other current
assets of $7.2 million, an increase in other assets of $8.4 million, a decrease
in accounts payable of $11.9 million and a decrease in other accruals of $6.8
million mainly due to timing of payments.
Net cash used in investing activities of $25.7 million for the 16 weeks ended
June 14, 2008 primarily reflected property expenditures totaling $29.7 million,
which included 1 major remodel, 1 major enlargement and 3 minor remodels
partially offset by proceeds from disposal of property of $3.1 million. For
fiscal 2008, we have planned capital expenditures of approximately $200 million,
which relate primarily to enlarging or remodeling supermarkets and converting
supermarkets to more optimal formats. Net cash provided by investing activities
of $32.9 million for the 16 weeks ended June 16, 2007 primarily reflected
47
cash received from the sale of shares of Metro, Inc. of $203.5 million, and net
sales of marketable securities of $20.4 million partially offset by an increase
in restricted cash of $142.9 million and property expenditures totaling $50.9
million, which included 2 new supermarkets, 4 major remodels and 3 minor
remodels.
Net cash provided by financing activities of $59.4 million for the 16 weeks
ended June 14, 2008 primarily reflected net proceeds under our revolving lines
of credit of $81.1 million, net proceeds under line of credit of $5.5 million,
an increase in book overdrafts of $17.2 million, partially offset by the
settlement of Series A warrants of $45.7 million. Net cash used in financing
activities of $52.5 million for the 16 weeks ended June 16, 2007 primarily
reflected principal payments on long term borrowings of $31.9 million and net
principal payments on revolving lines of credit of $30.0 million, partially
offset by proceeds from the exercise of stock options of $5.6 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 2008 at this time has been approved and we believe that our present cash
resources, including invested cash on hand, available borrowings from our Credit
Agreement and other sources, are sufficient to meet our needs.
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
modify the operating plan in order to ensure that we have appropriate resources.
WORKING CAPITAL
---------------
We had working capital of $149.1 million at June 14, 2008 compared to working
capital of $117.1 million at February 23, 2008. We had cash and cash equivalents
aggregating $129.1 million at June 14, 2008 compared to $100.7 million at
February 23, 2008. The increase in working capital was attributable primarily to
the following:
o An increase in cash and cash equivalents as detailed in the Consolidated
Statements of Cash Flows;
o A decrease in current portion of other financial liabilities due to the
exercise of Series A warrants by Yucaipa Corporate Initiatives Fund I,
L.P., Yucaipa American Alliance Fund I, L.P. and Yucaipa American Alliance
(Parallel) Fund I, L.P., and
o A decrease in accrued salaries, wages and benefits primarily due to
payments made in connection with our annual incentive programs.
Partially offset by the following:
o An increase in accounts payable (inclusive of book overdrafts) due to the
timing of payments.
48
LINE OF CREDIT
--------------
On January 16, 2008, we entered into a secured line of credit agreement with
Blue Ridge Investments, L.L.C. This agreement enables us to borrow funds on a
revolving basis subject to invested cash balances. Each borrowing bears interest
at a rate per annum equal to the BBA Libor Daily Floating Rate plus 0.10%. At
June 14, 2008 and February 23, 2008, we had borrowings outstanding under this
line of credit agreement of $17.2 million and $11.6 million, respectively. This
agreement expires December 31, 2008. These loans are collateralized by a first
priority perfected security interest in our ownership interest in the Columbia
Fund. See Note 5 - Cash, Cash Equivalents, Restricted Cash and Restricted
Marketable Securities, for further discussion on the Columbia Fund.
CREDIT AGREEMENT
----------------
On December 3, 2007, the 2005 Revolving Credit Agreement and Letter of Credit
Agreement were refinanced pursuant to a new $675 million Credit Agreement
("Credit Agreement"), with Banc of America Securities LLC, Bank of America, N.A.
Subject to borrowing base requirements, the Credit Agreement provides for a
five-year term loan of $82.9 million and a five-year revolving credit facility
of $592.1 million enabling us to borrow funds and issue letters of credit on a
revolving basis. The Credit Agreement includes a $100 million accordion feature
which gives us the ability to increase commitments from $675 million to $775
million. The Credit Agreement is collateralized by all assets of the company,
including, but not limited to, inventory, certain accounts receivable, pharmacy
scripts, owned real estate and certain Pathmark leaseholds. Borrowings under the
Credit Agreement bear interest based on LIBOR or Prime interest rate pricing.
Subject to certain conditions, we are permitted to pay cumulative cash dividends
on common shares as well as make bond repurchases. At June 14, 2008, there were
$251.0 million of loans and $236.4 million in letters of credit outstanding
under this agreement. As of June 14, 2008, after reducing availability for
borrowing base requirements, we had $178.4 million available under the Credit
Agreement.
On December 27, 2007, in order to facilitate the syndication of the Credit
Agreement under current market conditions, we entered into an Amended and
Restated Credit Agreement, whereby a portion of the revolving commitment was
converted into a $50 million term loan tranche which was collateralized by
certain real estate assets at an increased margin rate. This agreement expires
in December 2012.
SERIES A AND SERIES B WARRANTS
------------------------------
As part of the acquisition of Pathmark on December 3, 2007, we issued 4,657,378
and 6,965,858 roll-over stock warrants in exchange for Pathmark's 2005 Series A
and Series B warrants, respectively. The number of warrants issued was computed
based on the conversion factor of 0.46296. The Series A warrants were
exercisable at $18.36 and expired on June 9, 2008 and the Series B warrants are
exercisable at $32.40 and expire on June 9, 2015. These warrants were originally
valued using the price of A&P common stock of $30.05 per common share, the
quoted market price of A&P common stock on November 30, 2007, the last trading
day before the transaction closing date. The Tengelmann stockholders have the
right to approve any issuance of common stock under these warrants upon exercise
(assuming Tengelmann's outstanding interest is at least 25% and subject to
liquidity impairments defined within the Tengelmann Stockholder Agreement). In
addition, Tengelmann has the ability to exercise a "Put Right" whereby it has
the ability to require A&P to purchase A&P stock held by Tengelmann to settle
these warrants. Based on the rights provided to Tengelmann, A&P does not have
sole discretion to determine whether the payment upon exercise of these warrants
will be settled in cash or through issuance of an equivalent portion of A&P
shares. Therefore, these warrants are recorded as liabilities and
marked-to-market each reporting period based on A&P's current stock price.
49
On May 7, 2008, the 4,657,378 Series A warrants were exercised by Yucaipa
Corporate Initiatives Fund I, L.P., Yucaipa American Alliance Fund I, L.P. and
Yucaipa American Alliance (Parallel) Fund I, L.P. We opted to settle the Series
A warrants in cash totaling $45.7 million rather than issuing additional common
shares.
Included in "Nonoperating Income" on our Consolidated Statements of Operations
for the 16 weeks ended June 14, 2008, is a loss of $1.2 million for the Series A
warrants through the settlement date of May 7, 2008 and a gain of $27.1 million
for the Series B warrants market value adjustment. The value of the Series B
warrants were $79.0 million as of June 14, 2008 and is included in "Other
financial liabilities" on our Consolidated Balance Sheets. The following
assumptions and estimates were used in the Black-Scholes model:
Series B
------------
Expected life 7.0 years
Volatility 51.8%
Dividend yield range 0%
Risk-free interest rate range 3.95%
PUBLIC DEBT OBLIGATIONS
-----------------------
Outstanding notes totaling $590.4 million at June 14, 2008 consisted of $12.8
million of 9.125% Senior Notes due December 15, 2011, $142.4 million of 5.125%
Convertible Senior Notes due June 15, 2011, $235.2 million of 6.75% Convertible
Senior Notes due December 15, 2012 and $200.0 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%, 5.125% and 6.75% Notes. The 9.375% Notes are now callable at par
($25 per bond) and the 9.125% Notes are callable at a premium to par (103.042%).
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 Credit Agreement and do not contain cross default
provisions. All covenants and restrictions for 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 2007, the outstanding principal amount of our
7.75% Notes of $31.9 million due April 15, 2007 matured and was paid in full.
On December 18, 2007, we completed a public offering and issued $165 million
5.125% convertible senior notes due 2011 and $255 million 6.75% convertible
senior notes due 2012. The 2011 notes are not redeemable at our option at any
time. The 2012 notes are redeemable at our option on or after December 15, 2010,
at a redemption price of 102.70% and on or after December 15, 2011, at a
redemption price of 101.35%. The initial conversion price of the 2011 notes is
$36.40 representing a 30.0% premium to the offering price of $28.00 and the
initial conversion price of the 2012 notes is $37.80 representing a 35.0%
premium to the offering price of $28.00 at maturity, and at our option, the
notes are convertible into shares of our stock, cash, or a combination of stock
and cash. Concurrent with this offering, we entered into call options and
financing warrant transactions with financial institutions that are affiliates
of the underwriters of the notes to effectively increase the conversion price of
these notes and to reduce the potential dilution upon future conversion.
Conversion prices were effectively increased to $46.20 or a 65% premium and
$49.00 or a 75% premium for the 2011 and 2012 notes, respectively.
As of December 18, 2007, our Company did not have sufficient authorized shares
to provide for all potential issuances of common stock. Therefore, in accordance
with SFAS No. 133, "Accounting for Derivative
50
Instruments and Hedging Activities", our Company accounted for the conversion
features as freestanding instruments. The notes were recorded with a discount
equal to the value of the conversion features at the transaction date and will
be accreted to the par value of the notes over the life of the notes. The value
of the conversion features were determined utilizing the Black-Scholes option
pricing model, recorded as a long term liability. The portion of the conversion
feature for which there are not available shares is marked to market each
balance sheet date. During the 16 weeks ended June 14, 2008, the gain that was
recorded in "Nonoperating Income" on our Consolidated Statements of Operations
for the conversion features of the 5.125% and 6.75% convertible senior notes was
$11.1 million and $5.1 million, respectively. The fair value of the conversion
features classified as a liability as of June 14, 2008 was $8.5 million and nil
for the 5.125% and 6.75% convertible notes, respectively. The following
assumptions and estimates were used in the Black-Scholes model:
For the 16 weeks
ended
June 14, 2008
---------------------
Expected life 3.0 years - 4.5 years
Volatility 33.0%
Dividend yield range 0%
Risk-free interest rate range 3.38% - 3.73%
SHARE LENDING AGREEMENTS
------------------------
We have entered into share lending agreements, dated December 12, 2007, with
certain financial institutions, under which we have agreed to loan up to
11,278,988 shares of our common stock (subject to certain adjustments set forth
in the share lending agreements). These borrowed shares must be returned to us
no later than December 15, 2012 or sooner if certain conditions are met. If an
event of default should occur under the stock lending agreement and a legal
obstacle exists that prevents the Borrower from returning the shares, the
Borrower shall, upon written request of our Company, pay our Company, using
available funds, in lieu of the delivery of loaned shares, to settle its
obligation.
These financial institutions will sell the "borrowed shares" to investors to
facilitate hedging transactions relating to the issuance of our 5.125% and 6.75%
Convertible Notes. Pursuant to these agreements, we loaned 8,134,002 shares of
our stock of which 6,300,752 shares were sold to the public on December 18, 2007
in a public offering. We did not receive any proceeds from the sale of the
borrowed shares. We received a nominal lending fee from the financial
institutions pursuant to the share lending agreements.
Any shares we loan will be issued and outstanding. Investors that purchase
borrowed shares will be entitled to the same voting and dividend rights as any
other holders of our common stock; however, the financial institutions will not
have such rights pursuant to the share lending agreements. The obligation of the
financial institutions to return the borrowed shares has been accounted for as a
prepaid forward contract and, accordingly, shares underlying this contract are
removed from the computation of basic and dilutive earnings per share. On a net
basis, this transaction will have no impact on earnings per share.
51
CALL OPTION AND FINANCING WARRANT
---------------------------------
Concurrent with our issuance of the convertible senior notes, we entered into
call option and financing warrant transactions with financial institutions that
are affiliates of the underwriters to reduce the potential dilution upon future
conversion of the notes and to effectively increase the conversion price of the
notes. The call options allow our Company to purchase common shares at $36.40
with respect to the 5.125% notes and $37.80 with respect to the 6.75% notes.
These purchased shares would be used to satisfy the conversion of the
convertible senior notes. The call options are accounted for as free standing
derivatives and $73.5 million is recorded as equity in the Consolidated Balance
Sheet. The financing warrants allow holders to purchase common shares at $46.20
with respect to the 5.125% notes and $49.00 with respect to the 6.75% notes. The
financing warrants were valued at $36.8 million at the issuance date. At the
issuance date our Company did not have sufficient authorized shares to provide
all potential issuances of common stock. Therefore, the financing warrants are
accounted for as freestanding derivatives, required to be settled in cash until
sufficient shares are available and are recorded as a long-term liability in the
Consolidated Balance Sheet. The financing warrants are marked to market each
reporting period utilizing the Black-Scholes option pricing model and are valued
at $24.7 million as of June 14, 2008. During the 16 weeks ended June 14, 2008,
we recorded a gain of $6.5 million included in "Nonoperating income" on our
Consolidated Statements of Operations. The following assumptions and estimates
were used in the Black-Scholes model:
For the 16 weeks
ended
June 14, 2008
---------------------
Expected life 3.3 years - 4.8 years
Volatility 33.0%
Dividend yield range 0%
Risk-free interest rate range 3.38% - 3.73%
OTHER
-----
We are the guarantor of a loan of $1.3 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"). When the
Assigned 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 14, 2008, 233 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 $722.2 million, which could be partially or
totally offset by reassigning or subletting such leases.
Our existing senior debt rating was Caa1 with stable outlook with Moody's
Investors Service ("Moody's") as of June 14, 2008. Our existing senior debt
rating was B with positive outlook and was removed from CreditWatch with
Standard & Poor's Ratings Group ("S&P") as of June 14, 2008. Also S&P assigned
B- ratings to our $165 million 5.125% convertible senior notes due 2011 and our
$255 million 6.75% convertible senior notes due 2012. Moody's assigned a Caa1
rating to our $165 million 5.125% convertible senior notes due 2011 and our $255
million 6.75% convertible senior notes due 2012.
Our liquidity rating was SGL3 with Moody's as of June 14, 2008. Our recovery
rating was 5 with S&P as of June 14, 2008 indicating a modest expectation of
10%-30% recovery of our senior debt to our lenders. Future rating changes could
affect the availability and cost of financing to our Company.
52
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, legal costs and other data. Legal expenses incurred in connection with
workers' compensation and general liability claims are charged to the specific
claim to which costs pertain. The required liability is also subject to
adjustment in the future based upon the changes in claims experience, including
changes in the number of incidents (frequency) and changes in the ultimate cost
per incident (severity).
Long-Lived Assets
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.
The value of the assets is determined based on estimates of future cash flows.
Any impairment 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
improve, there may be a need to take further actions which may result in 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 adjust the
charges originally accrued for these events for 1) interest accretion, 2)
settlements on leases or sold properties, and 3) changes in estimates in future
sublease rental assumptions. Net adjustments, all of which have been disclosed
in the Notes to the Consolidated Financial Statements, for changes have been
cumulatively approximately 5% from the date of inception, with the most
significant adjustments being made prior to 2000. Adjustments are predominantly
due to fluctuations in the real estate market from the time the original charges
are incurred until the properties were actually settled.
As of June 14, 2008, we had recorded liabilities for estimated probable
obligations of $187 million. Of this amount, $19 million relates to stores
closed in the normal course of business, $27 million relates to stores and
warehouses closed as part of the asset disposition initiatives (see Note 9 of
our Consolidated Financial Statements), and $141 million relates to stores
closed as part of our discontinued operations (see Note 8 of our Consolidated
Financial Statements). Due to the long-term nature of the lease commitments, it
is possible that current accruals, which are based on estimates of vacancy costs
and sublease income, will change in the future as economic conditions change in
the real estate market; however, we are unable to estimate the impact of such
changes at this time and the existing obligations are management's best estimate
of these obligations at this time.
53
Conversion Feature, Financial Warrants, and Warrant Liability
We have issued several financial instruments which are recorded as liabilities
in our financial statements and marked to market each reporting period using the
Black-Scholes option pricing model. The value of these liabilities may change as
a result of changes in A&P's stock price, the remaining time until maturity, and
the current interest rate.
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 the weighted average discount rate at which obligations can
be effectively settled, the anticipated rate of future increases in compensation
levels, the expected long-term rate of return on assets, increases or trends in
health care cost, and certain employee related factors, such as turnover,
retirement age and mortality.
The discount rate is determined by taking into account the actual pattern of
maturity of the benefit obligations. To generate the year-end discount rate, a
single rate is developed using a yield curve which is derived from multiple high
quality corporate bonds, discounting each future year's projected cash flow, and
determining the equivalent single discount rate. A discount rate of 5.75% was
selected for the February 23, 2008 disclosures. We use independent actuaries to
assist us in determining the discount rate assumption and measuring our plans'
obligations.
The rate of compensation increase is determined based upon a scale of merit and
promotional increases according to duration plus an economic increase per year.
Our long-term rate of return is developed by taking into account the target
allocations contained in each plan's investment policy, as of the beginning of
the year, and reflecting long term historical data, with greater weight given to
recent years. Under this approach, separate analyses are performed to determine
the expected long-term rate of inflation, real rates of return for each asset
class, and the correlations among the returns for the various asset classes. We
use independent actuaries to assist us in determining our long-term rate of
return assumptions.
We believe that our current assumptions used to estimate plan obligations and
annual expense are appropriate in the current economic environment. However, if
economic conditions change, we may need to change some of our assumptions, and
the resulting changes may materially affect our pension and other postretirement
obligations in the Consolidated Balance Sheets and our future expense in the
Consolidated Statement of Operations. Actual results that differ from our
Company's assumptions are accumulated and amortized over future periods into the
Consolidated Statement of Operations.
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. Physical inventory counts are taken every period for fresh inventory,
approximately twice per fiscal year on a staggered basis for the remaining
merchandise inventory in stores, and annually for inventory in distribution
centers and supplies. The average shrinkage rate resulting from the physical
inventory counts is applied to the ending inventory balance in each store as of
the balance sheet date to provide for estimated shrinkage from the date of the
last physical inventory count for that location. Adjustments to the stock loss
reserve based on physical inventories have not been material.
54
Income Taxes
As discussed in Note 14 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.
We adopted the provisions of Financial Accounting Standards Board ("FASB")
Interpretation No. 48, Accounting for Uncertainty in Income Taxes--an
Interpretation of FASB Statement 109 ("FIN 48") as of February 25, 2007. The
cumulative effect of the adoption of the recognition and measurement provisions
of FIN 48 resulted in a $24.4 million increase to the February 25, 2007 balance
of retained earnings. Results of prior periods have not been restated. FIN 48
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return. FIN 48 requires that we determine whether the benefits of
our tax positions are more likely than not of being sustained upon audit based
on the technical merits of the tax position. For tax positions that are more
likely than not of being sustained upon audit, we recognize the largest amount
of the benefit that is more likely than not of being sustained in our
Consolidated Financial Statements.
For tax positions that are not more likely than not of being sustained upon
audit, we do not recognize any portion of the benefit in our Consolidated
Financial Statements. Our policy for interest and penalties under FIN 48 related
to income tax exposures was not impacted as a result of the adoption of the
recognition and measurement provisions of FIN 48. Therefore, we continue to
recognize interest and penalties as incurred within "Benefit from (provision
for) income taxes" in our Consolidated Statements of Operations.
Our Company makes estimates of the potential liability based on its assessment
of all potential tax exposures. In addition, we use factors such as applicable
tax laws and regulations, current information and past experience with similar
issues to make these adjustments. The increase in our liabilities for
unrecognized tax benefits as of the date of adoption of approximately $165
million was due mostly to our assessment of potential exposure concerning a
deduction taken in the Company's fiscal 2005 federal income tax return. Despite
the Company's belief that its tax return position is supportable, the Company
believes that the position may not be fully sustained upon review by tax
authorities. Such amount was adjusted to approximately $154 million in the
fourth quarter of fiscal 2007 in connection with the Company's fiscal 2006 tax
return to provision reconciliation. As we were in a full valuation allowance
position, the approximate $11 million adjustment had no effect on the Company's
earnings. In addition, the acquisition of Pathmark Stores Inc. increased this
balance to the current $164 million. Our Consolidated Balance Sheet has been
adjusted to reflect the liabilities for uncertain tax positions and deferred tax
assets for net operating losses, since such losses are available to absorb the
taxable income attributable to the unrecognized tax benefits. Thus, there was no
impact on the Company's retained earnings resulting from the increase in the
liability for unrecognized tax benefits.
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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 Notes as of June 14, 2008 of $592.9 million because they are at fixed
interest rates. However, we do have cash flow exposure on our committed bank
lines of credit of $268.2 million due to our variable floating rate pricing.
Accordingly, during the first quarters of fiscal 2008 and fiscal 2007, a
presumed 1% change in the variable floating rate would have impacted interest
expense by $0.6 million and $0.1 million, respectively.
Foreign Exchange Risk
---------------------
We are exposed to foreign exchange risk to the extent of adverse fluctuations in
the Canadian dollar. As we have approximately $1.0 million in assets denominated
in foreign currency, we do not believe that a change in the Canadian currency of
10% will have a material effect on our Consolidated Statements of Operations or
Cash Flows.
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 foregoing, 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 the period covered by this report.
There have been no changes during our Company's fiscal quarter ended June 14,
2008 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
56
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.
PART II. OTHER INFORMATION
ITEM 1 - Legal Proceedings
Refer to Note 17 - Commitments and Contingencies for discussion of our legal
proceedings.
ITEM 1A - Risk Factors
Refer to ITEM 1A - Risk Factors in our Fiscal 2007 Form 10-K
ITEM 2 - Unregistered Sales of Equity Securities and Use of Proceeds
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
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ITEM 6 - Exhibits
(a) Exhibits required by Item 601 of Regulation S-K
EXHIBIT NO. DESCRIPTION
---------- -----------
10.50 Warehousing, Distribution and Related Services Agreement
dated March 7, 2008 by and between the Company and C&S
Wholesale Grocers, Inc. **
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
** Confidential treatment has been requested for certain
portions thereof pursuant to a confidential treatment
request filed with the Securities and Exchange Commission
(the "Commission") on July 18, 2008. Such provisions have
been filed separately with the Commission.
58
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, 2008 By: /s/ Melissa E. Sungela
-----------------------------------------------
Melissa E. Sungela, Vice President,
Corporate Controller (Chief Accounting Officer)
59