Conformed Copy
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended September 11, 1999 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) (Zip Code)
Registrant's telephone number, including area code 201-573-9700
------------
- -------------------------------------------------------------------------
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 XXX NO
--------- ---------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at September 11, 1999
----- ---------------------------------
Common stock - $1 par value 38,367,216 shares
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
STATEMENTS OF CONSOLIDATED OPERATIONS
(Dollars in thousands, except share amounts)
(Unaudited)
12 Weeks Ended 28 Weeks Ended
Sept. 11, Sept. 12, Sept. 11, Sept. 12,
1999 1998 1999 1998
----------- ----------- ----------- -----------
Sales $2,284,380 $2,330,249 $5,398,102 $5,408,635
Cost of merchandise sold (1,623,079) (1,656,971) (3,865,212) (3,849,044)
---------- ---------- ---------- ----------
Gross margin 661,301 673,278 1,532,890 1,559,591
Store operating, general and
administrative expense (634,933) (644,625) (1,516,232) (1,486,707)
---------- ---------- ---------- ----------
Income from operations 26,368 28,653 16,658 72,884
Interest expense (17,910) (15,781) (42,304) (36,813)
Interest income 1,561 1,559 3,339 3,637
---------- ---------- ---------- ----------
Income (loss) before
income taxes 10,019 14,431 (22,307) 39,708
(Provision) Benefit for
income taxes (4,641) (3,480) 8,139 (9,588)
---------- ---------- ---------- ----------
Net income (loss) $ 5,378 $ 10,951 $ (14,168) $ 30,120
========== ========== ========== ==========
Earnings (loss) per share:
Net income (loss)per share -
basic and diluted $ .14 $ .29 $( .37) $ .79
========== ========== ========== ==========
Weighted average number of
common shares outstanding 38,358,284 38,294,716 38,335,948 38,282,287
Common stock equivalents 221,806 54,427 137,615 72,025
---------- ---------- ---------- ----------
Weighted average number of
common and common
equivalent shares
outstanding 38,580,090 38,349,143 38,473,563 38,354,312
========== ========== ========== ==========
See Notes to Quarterly Report on Page 7.
1
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND
---------------------------------------------------
COMPREHENSIVE (LOSS) INCOME
---------------------------
(Dollars in thousands, except share amounts)
(Unaudited)
28 Week Period FY 1999
- ----------------------
Una- Accumu-
mortized lated
Value Other
Addi- of Rest- Compre- Total
tional tricted hensive Share-
Common Paid-in Stock Retained Income holders'
Stock Capital Grants Earnings (Loss) Equity
------ ------- ------ -------- ------- -------
Balance at February
28, 1999,
38,290,716 shares $38,291 $454,971 $ - $413,034 $(69,039) $837,257
Net Loss (14,168) (14,168)
Other Comprehensive
Income:
Foreign Currency
Translation
Adjustment 2,478 2,478
Issuance of 20,000
Shares of Common
Stock 20 631 (651) -
Exercise of Stock
Options, 56,500 shares 56 1,499 1,555
Amortization of
Restricted Stock Grants 150 150
Cash Dividends
($.10 per share) (7,663) (7,663)
------- -------- ------ -------- -------- --------
Balance at September
11, 1999 $38,367 $457,101 $ (501) $391,203 $(66,561) $819,609
======= ======== ====== ======== ======== ========
28 Week Period FY 1998
- ----------------------
Balance at March 1,1998,
38,252,966 shares 38,253 $453,894 $ - $495,510 $(61,025) $926,632
Net Income 30,120 30,120
Other Comprehensive
Income:
Foreign Currency
Translation
Adjustment (10,984) (10,984)
Exercise of Stock
Options, 34 954 988
33,750 shares
Cash Dividends
($.10 per share) (7,654) (7,654)
------- -------- ------ -------- -------- --------
Balance at September
12, 1998 $38,287 $454,848 $ - $517,976 $(72,009) $939,102
======= ======== ====== ======== ======== ========
See Notes to Quarterly Report on Page 7
2
Comprehensive Income (Loss)
- ---------------------------
12 Weeks Ended 28 Weeks Ended
Sept. 11, Sept. 12, Sept. 11, Sept. 12,
1999 1998 1999 1998
---------- ---------- ---------- ----------
Net Income (Loss) $ 5,378 $10,951 $(14,168) $30,120
Foreign Currency
Translation
Adjustment (1,306) (5,083) 2,478 (10,984)
-------- -------- -------- -------
Total Comprehensive
Income (Loss) $ 4,072 $ 5,868 $(11,690) $19,136
======== ======= ======== =======
See Notes to Quarterly Report on Page 7.
3
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
CONSOLIDATED BALANCE SHEETS
--------------------------
(Dollars in thousands)
Sept. 11, 1999 Feb. 27, 1999
-------------- -------------
(Unaudited)
ASSETS
- ------
Current assets:
Cash and short-term investments $144,395 $136,810
Accounts receivable 184,588 204,700
Inventories 779,396 841,030
Prepaid expenses and other assets 71,060 41,497
---------- ----------
Total current assets 1,179,439 1,224,037
---------- ----------
Property:
Property owned 1,694,646 1,597,459
Property leased 84,559 89,028
---------- ----------
Property-net 1,779,205 1,686,487
Other assets 219,390 231,217
---------- ----------
Total Assets $3,178,034 $3,141,741
========== ==========
See Notes to Quarterly Report on Page 7.
4
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
CONSOLIDATED BALANCE SHEETS
---------------------------
(Dollars in thousands)
Sept. 11, 1999 Feb. 27, 1999
-------------- -------------
(Unaudited)
LIABILITIES & SHAREHOLDERS' EQUITY
- ----------------------------------
Current liabilities:
Current portion of long-term debt $ 3,413 $ 4,956
Current portion of obligations under
capital leases 11,688 11,483
Accounts payable 501,362 557,318
Book overdrafts 174,075 160,288
Accrued salaries, wages and benefits 155,693 152,107
Accrued taxes 67,283 54,819
Other accruals 209,797 193,092
---------- ----------
Total current liabilities 1,123,311 1,134,063
---------- ----------
Long-term debt 774,109 728,390
---------- ----------
Obligations under capital leases 110,467 115,863
---------- ----------
Deferred income taxes 27,034 23,309
---------- ----------
Other non-current liabilities 323,504 302,859
---------- ----------
Commitments and contingencies
Shareholders' 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 38,367,216 and
38,290,716 shares, respectively 38,367 38,291
Additional paid-in capital 457,101 454,971
Unamortized value of restricted
stock grant (501) -
Accumulative other comprehensive loss (66,561) (69,039)
Retained earnings 391,203 413,034
---------- ----------
Total shareholders' equity 819,609 837,257
---------- ----------
Total liabilities and shareholders'
equity $3,178,034 $3,141,741
========== ==========
See Notes to Quarterly Report on Page 7.
5
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
28 Weeks Ended
Sept. 11, 1999 Sept. 12, 1998
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (14,168) $30,120
Adjustments to reconcile net (loss) income
to cash provided by operating activities:
Store/Facilities exit charge and asset
write-off 31,347 -
Depreciation and amortization 122,302 126,361
Deferred income tax (benefit) provision (24,019) 5,033
Gain on disposal of owned property (1,240) (3,133)
Decrease in receivables 20,839 23,925
Decrease (increase) in inventories 64,157 (7,652)
Increase in prepaid expenses
and other current assets (393) (112)
Decrease in other assets 926 5,433
(Decrease) increase in accounts payable (57,852) 86,199
Decrease in accrued salaries,
wages and benefits (1,428) (7,741)
Increase in accrued taxes 12,424 3,175
Increase in other accruals
and other liabilities 6,669 17,706
Other operating activities, net (2,410) (4,535)
--------- ---------
Net cash provided by operating activities 157,154 274,779
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for property (256,766) (208,224)
Proceeds from disposal of property 68,116 5,831
--------- ---------
Net cash used in investing activities (188,650) (202,393)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Changes in short-term debt (23,100) 22,500
Proceeds under revolving lines of credit 85,000 240,000
Payments on revolving lines of credit (215,000) (275,000)
Proceeds from long-term borrowings 200,110 3,600
Payments on long-term borrowings (2,834) (3,051)
Principal payments on capital leases (6,227) (6,463)
Deferred financing fees (6,298) -
Increase (decrease) in book overdrafts 12,549 (9,593)
Proceeds from stock options exercised 1,555 988
Cash dividends (7,663) (7,654)
--------- ---------
Net cash provided by (used in) financing 38,092 (34,673)
activities
Effect of exchange rate changes on
cash and short-term investments 989 (1,600)
--------- ---------
NET INCREASE IN CASH AND
SHORT-TERM INVESTMENTS 7,585 36,113
CASH AND SHORT-TERM INVESTMENTS
AT BEGINNING OF PERIOD 136,810 70,937
--------- ---------
CASH AND SHORT-TERM INVESTMENTS
AT END OF PERIOD $144,395 $107,050
========= =========
See Notes to Quarterly Report on Page 7.
6
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
1) BASIS OF PRESENTATION
The consolidated financial statements for the 28 week period ended
September 11, 1999 and September 12, 1998 are unaudited, and in the
opinion of Management, all adjustments necessary for a fair presentation
of these financial statements have been included. The adjustments
consisted only of normal recurring items, except for the store and
facilities exit costs discussed in Note 5 below. Interim results are not
necessarily indicative of results for a full year.
The consolidated financial statements include the accounts of the Company
and all majority-owned subsidiaries.
This Form 10-Q should be read in conjunction with the Company's
consolidated financial statements and notes incorporated by reference in
the 1998 Annual Report on Form 10-K.
Certain reclassifications have been made to the prior periods' financial
statements in order to conform to the current period presentation.
2) INCOME TAXES
The income tax provisions recorded for the 28 week period ended in fiscal
years 1999 and 1998 reflect the Company's estimated expected annual tax
rates applied to their respective domestic and foreign financial results.
For the 28 week period ended September 11, 1999, the income tax benefit
of $8.1 million relates to taxes on U.S. and Canadian income. For the 28
week period ended September 12, 1998, the income tax provision reflected
mainly taxes on U.S. operations as the Canadian operation income tax
expense was principally offset by the reversal of its deferred tax asset
valuation allowance. During the 28 week period of fiscal 1998, the
Company reversed $7.7 million of the Canadian valuation allowance to the
extent that the Canadian operation had taxable income.
3) FOOD BASICS FRANCHISING
As of September 11, 1999, the Company served 62 Food Basics franchised
stores. These franchisees are required to purchase inventory exclusively
from the Company which acts as a wholesaler to the franchisees. The
Company had sales to these franchised stores of $259 million and $207
million for the 28 week period ended in fiscal years 1999 and 1998,
respectively. In addition, the Company subleases the stores and leases
the equipment in the stores to the franchisees. The Company also
provides merchandising, advertising, accounting and other consultative
services to the franchisees for which it receives a fee which mainly
represents the reimbursement of costs incurred to provide such services.
7
Included in other assets are Food Basics franchising business
receivables, net of allowance for doubtful accounts, amounting to
approximately $38.5 million and $36.4 million at September 11, 1999 and
February 27, 1999, respectively.
The inventory notes are collateralized by the inventory in the stores,
while the equipment lease receivables are collateralized by the equipment
in the stores. The current portion of the inventory notes and equipment
leases, net of allowance for doubtful accounts, amounting to
approximately $2.4 million and $2.1 million are included in accounts
receivable at September 11, 1999 and February 27, 1999, respectively.
The repayment of the inventory notes and equipment leases are dependent
upon positive operating results of the stores. To the extent that the
franchisees incur operating losses, the Company establishes an allowance
for doubtful accounts. The Company continually assesses the sufficiency
of the allowance on a store by store basis based upon the operating
losses incurred and the related collateral underlying the amounts due
from the franchisees. In the event of default by a franchisee, the
Company reserves the option to reacquire the inventory and equipment at
the store and operate the franchise as a corporate owned store.
4) NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities" ("SFAS 133"). This
Statement requires that all derivative instruments be measured at fair
value and recognized in the statement of financial position as either
assets or liabilities. In addition, the accounting for changes in the
fair value of a derivative (gains and losses) depends on the intended use
of the derivative and the resulting designation. For a derivative
designated as a hedge, the change in fair value will be recognized as a
component of other comprehensive income; for a derivative not designated
as a hedge, the change in the fair value will be recognized in the
statement of operations.
In June 1999, the FASB issued SFAS No. 137, "Accounting For Derivative
Instruments And Hedging Activities - Deferral Of The Effective Date of
FASB Statement No. 133" which delays the adoption of SFAS 133 for one
year, to fiscal years beginning after June 15, 2000. The Company plans
to adopt SFAS 133 in the first quarter of fiscal 2001. The Company is
currently evaluating the impact this pronouncement will have on the
Consolidated Financial Statements.
5) STORE AND FACILITIES EXIT COSTS
In May 1998, the Company initiated a vigorous assessment of all aspects
of its business operations in order to identify the factors that were
impacting the performance of the Company.
8
As a result of the above assessment, in the third quarter of fiscal 1998,
the Company decided to exit two warehouse facilities, a coffee plant and
a bakery plant in Canada. In connection with the exit plan, the Company
recorded a charge of approximately $11 million consisting of $7 million
of severance, $3 million of facilities occupancy costs for the period
subsequent to closure and $1 million to write-down the facilities to
their estimated fair value.
At February 27, 1999, the Company closed and terminated operations with
respect to the warehouses and the coffee plant. The volume associated
with the two warehouses has been transferred to other warehouses in close
geographic proximity. Further, the manufacturing processes of the coffee
plant have been transferred to the Company's remaining coffee processing
facility. The processing associated with the Canadian bakery has been
outsourced effective January 1999.
In addition, on December 8, 1998, the Company's Board of Directors
approved a plan which included the exit of 127 underperforming stores
throughout the United States and Canada and the disposal of two other
properties. Included in the 127 stores are 31 stores representing the
entire Richmond, Virginia market. Further on January 28, 1999, the Board
of Directors approved the closure of five additional underperforming
stores. In connection with the Company's plan to exit these 132 stores
and the write-down of two properties, the Company recorded a fourth
quarter charge of approximately $215 million. This $215 million charge
consists of $8 million of severance, $1 million of facilities occupancy
costs, $114 million of store occupancy costs, which principally relates
to the present value of future lease obligations, net of anticipated
sublease recoveries, which extend through fiscal 2028, an $83 million
write-down of store fixed assets and a $9 million write-down to their
estimated fair value for the two properties which are held for sale. To
the extent fixed assets included in stores identified for closure could
be utilized in other continuing stores, the Company has or will transfer
those assets to continuing stores. To the extent those fixed assets
cannot be transferred, the Company will scrap them and accordingly, the
write-down was calculated based upon an estimated scrap value. This
fourth quarter charge of $215 million was reduced by approximately $2
million due to changes in estimates of pension withdrawal liabilities and
fixed asset write-downs from the time the original charge was recorded.
In addition, there were additional charges related to the plan which
could not be accrued at February 27, 1999 because they did not meet the
criteria for accrual under EITF 94-3, but will be expensed as incurred as
the plan is executed. In the 28 week period of fiscal 1999, the Company
recorded an additional pretax charge of $10 million for severance related
to the 132 stores.
The severance charges of the above items totaled approximately $25
million and resulted from the termination of 2,133 employees. The
9
Company paid $11 million of these severance costs as of September 11,
1999 and expects the remainder will be paid by the first quarter of
fiscal 2000.
On April 26, 1999, the Company announced that it had reached definitive
agreements to sell 14 stores in the Atlanta, Georgia market, two of which
were previously included in the Company's store exit program. In
conjunction with the sale, the Company decided to exit the entire Atlanta
market and close the remaining 22 stores, as well as the distribution
center and administrative office. Accordingly, the Company recorded a
fiscal 1999 28 week period net pretax charge of approximately $5 million.
This charge is comprised of severance of $6 million, future lease
commitments of $11 million, net of a $12 million gain related to the
disposition of fixed and intangible assets. The net charge is recorded
as "store operating, general and administrative expense". The Company
paid $3 million of the total severance charge related to the Atlanta exit
as of September 11, 1999 which resulted from the termination of 1,002
employees. The remaining $3 million of severance will be paid by the
first quarter of fiscal year 2000.
The following tabular reconciliation summarizes the activity related to
the aforementioned charges since the beginning of the fiscal year.
Reserve Reserve
Balance Balance
at at
February September
(in thousands) 28, 1999 Utilization Addition (1) 11, 1999
- -------------- -------- ----------- -------- ---------
Store Occupancy $114,532 $ 9,104 (2) $12,894 $136,530
Severance and Benefits 10,066 (14,611) 15,265 10,720
Facilities occupancy 4,038 (1,862) 3,188 5,364
-------- -------- ------- --------
Total $128,636 $(7,369) $31,347 $152,614
======== ======== ======= ========
(1) The addition represents an increase to the store occupancy reserve for
the present value interest accrued and the additional severance cost and
the cost (including store occupancy, severance and facilities costs) of
exiting the Atlanta market.
(2) Store occupancy utilization is comprised of $13.3 million of lease
payments for the period, net of $22.4 million of realized gains on the
assignment of leases which was included in the original charge recorded
during fiscal 1998.
As of September 11, 1999, the Company closed 117 of the 132 stores
identified, including all 31 stores in the Richmond, Virginia market and 34
of the Atlanta store exit program. The remaining 15 stores will be closed
over the next two quarters of fiscal 1999.
10
At September 11, 1999, $45.4 million of the reserve is included in "Other
accruals" and $107.2 million is included in "Other non-current liabilities"
in the accompanying consolidated balance sheet.
Based upon current available information, Management evaluated the reserve
balance as of September 11, 1999 and has concluded that it is adequate.
Included in the accompanying statement of operations are the operating
results of the 132 underperforming stores and the 34 Atlanta stores which
the Company is exiting. The operating results of these stores for the 28
week period ended September 11, 1999 and September 12, 1998 are as follows:
(in thousands) 28 Weeks Ended
- -------------- -------------------
Sept. 11, Sept. 12,
1999 1998
-------- --------
Sales $185,022 $602,049
======== ========
Operating Loss $(26,131) $(18,071)
======== ========
6) OPERATING SEGMENTS
During the fourth quarter of fiscal 1998, the Company adopted SFAS No.
131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS 131"). This statement establishes standards for
reporting information about operating segments in annual financial
statements and selected information in interim financial statements. It
also establishes standards for related disclosures about products and
services and geographic areas. 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.
The Company's chief operating decision maker is the Chief Executive
Officer.
The Company currently operates in three reportable segments: United
States Retail, Canada Retail and Wholesale. The retail segments are
comprised of retail supermarkets in the United States and Canada, while
the wholesale segment is comprised of the Company's Canadian store
franchising operation which includes serving as the exclusive wholesaler
to such franchised stores.
The accounting policies for the segments are the same as those described
in the summary of significant accounting policies incorporated in the
Company's Fiscal 1998 Annual Report. The Company measures segment
performance based upon operating profit.
11
Interim information on segments is as follows:
(in thousands)
28 Week Period
Fiscal 1999
- ------------------ U.S. Canada Total
Retail Retail Wholesale Company
---------- -------- --------- ----------
Sales $4,292,967 $845,873 $259,262 $5,398,102
Depreciation and amortization 108,021 14,281 - 122,302
Operating (loss) income (3,485) 12,614 7,529 16,658
Interest expense (35,063) (7,241) - (42,304)
Interest income 253 1,441 1,645 3,339
(Loss) income before taxes (38,295) 6,814 9,174 (22,307)
Total assets 2,592,507 524,130 61,397 3,178,034
Capital expenditures 228,061 28,705 - 256,766
28 Week Period
Fiscal 1998
- ------------------- U.S. Canada Total
Retail Retail Wholesale Company
---------- -------- --------- ----------
Sales $4,400,996 $801,256 $206,383 $5,408,635
Depreciation and amortization 113,715 12,646 - 126,361
Operating income 52,002 16,237 4,645 72,884
Interest expense (29,935) (6,878) - (36,813)
Interest income 391 1,471 1,775 3,637
Income before taxes 22,458 10,830 6,420 39,708
Total assets 2,638,878 370,893 52,442 3,062,213
Capital expenditures 182,771 25,453 - 208,224
12
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
ITEM 2
- -------
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
12 WEEKS ENDED SEPTEMBER 11, 1999
---------------------------------
OPERATING RESULTS
Sales for the second quarter ended September 11, 1999 of $2.3 billion
decreased $45.9 million or 2.0% from the prior year second quarter amount.
The opening of 38 stores in new locations, excluding replacement stores,
since the beginning of the second quarter of fiscal 1998 added approximately
$128 million or 5.5% to sales in the second quarter of fiscal 1999. In
addition, wholesale sales to the Food Basics franchised stores increased
$31.5 million or 37.5% to $115.6 million for the 12 weeks ended September
11, 1999, which increased total Company sales by 1.4%. These increases were
partially offset by the closure of 207 stores, excluding replacement stores,
since the beginning of the second quarter of fiscal 1998, which reduced
total sales by approximately $285 million or 12.2% in the second quarter of
fiscal 1999. An increase in the Canadian exchange rate improved second
quarter fiscal 1999 sales by $6 million or 0.2%. In addition, same store
sales ("same store sales" referred to herein include replacement stores)
increased 4.3% or $81.4 million from the same period last year.
Average weekly sales per supermarket were approximately $246,700 versus
$208,600 for the corresponding period of the prior year resulting in a 18.3%
increase. Same store sales for Canadian operations increased 9.4% from the
prior year and same store sales for U.S. operations increased 3.3% from the
prior year.
Gross margin as a percent of sales increased 6 basis points to 28.95% in the
second quarter of fiscal 1999 from 28.89% for the second quarter of fiscal
1998. The gross margin dollar decrease of $12 million resulted from a
decrease in the sales volume of $19 million, partially offset by an increase
in the gross margin rate of $6 million and an increase in the Canadian
exchange rate of $1 million. The U.S. operations gross margin decrease of
$23 million resulted from a decrease in sales volume of $33 million
partially offset by an increase of $10 million in the gross margin rate.
The Canadian operations gross margin increase of $11 million resulted from
an increase of $14 million in sales volume, an increase of $1 million in the
Canadian exchange rate, partially offset by a decrease of $4 million in the
gross margin rate.
Store operating, general and administrative expense decreased $9.7 million
compared to the corresponding period of the prior year. The decrease is due
principally to the reduction in occupancy and labor expenses as a result of
store closings, offset in part, by charges related to Project Great Renewal.
Also included in store operating, general and administrative expense for
13
1999 are professional fees of $4 million associated with the implementation
of the store exit program, and costs of approximately $3 million related
to the conversion of additional stores to the Food Basics format.
As of September 11, 1999, the Company closed 117 of the 132 stores
identified as part of Project Great Renewal and 34 stores relating to the
Atlanta store exit program. The remaining 15 stores will be closed over the
next two quarters of fiscal 1999. Further, during the next two quarters of
fiscal 1999, the Company expects to incur pretax losses relating to Project
Great Renewal ranging between $30 and $40 million which are not currently
accruable. These amounts principally represent operating losses of the
remaining 15 stores prior to closure, employee termination costs which have
not been communicated to the affected employees as of September 11, 1999,
and costs related to the conversion of stores to the Food Basics format.
Interest expense increased $2.1 million or 13.5% from the corresponding
period of the previous year, primarily due to the additional present value
interest related to the future lease obligations of the store exit and
Atlanta exit programs as well as the issuance of $200 million 9.375% senior
quarterly interest bonds on August 6, 1999.
Income before income taxes for the second quarter ended September 11, 1999
was $10 million compared to $14 million for the comparable period in the
prior year for a decrease of $4 million. The lower income is attributable
principally to initiatives under the Company's Project Great Renewal and the
increase in interest expense.
The income tax expense recorded in the second quarter of fiscal 1999
reflects the Company's estimated expected annual tax rates applied to its
respective domestic and foreign operations. The effective tax rate for the
second quarter of fiscal 1999 was 46.32%. The second quarter fiscal 1998
income tax provision mainly reflects taxes on U.S. income, as the Canadian
income tax expense was principally offset by the reversal of its deferred
tax asset valuation allowance. During the second quarter of fiscal 1998,
the Canadian operations generated pretax earnings and reversed a portion of
the valuation allowance to the extent of such pretax earnings. The reversal
of the valuation allowance amounted to $2.8 million for the second quarter
of fiscal 1998. Although Canada generated pretax earnings in the second
quarter of fiscal 1998, at September 12, 1998, the Company was unable to
conclude that the Canadian deferred tax assets were more likely than not to
be realized. This conclusion was based in part on Management's assessment
of the competitive Canadian marketplace and the level of the Canadian pretax
earnings, which for financial statement purposes is higher than the taxable
income for tax purposes due to differences between the financial statement
and income tax treatment of certain items.
14
MANAGEMENT'S DISCUSSION AND ANALYSIS
28 WEEKS ENDED SEPTEMBER 11, 1999
---------------------------------
OPERATING RESULTS
Sales for the 28 weeks ended September 11, 1999 of $5.4 billion decreased
$10.5 million or 0.2% from the prior year. The opening of 40 stores in new
market areas, excluding replacement stores, since the beginning of fiscal
1998 added approximately $299 million or 5.5% to sales in the 28 week period
of fiscal 1999. In addition, wholesale sales to the Food Basics franchised
stores increased $52.9 million or 25.6% to $259.3 million for the 28 week
period ended September 11, 1999. These increases were partially offset by
the closure of 226 stores, excluding replacement stores, since the beginning
of fiscal 1998, which reduced total sales by approximately $554 million or
10.2% in the 28 week period of fiscal 1999. A decrease in the Canadian
exchange rate reduced sales by $16 million or 0.3% in the 28 week period of
fiscal 1999. In addition, same store sales ("same store sales" referred to
herein include replacement stores) increased 4.9% or $212.6 million from the
same period last year.
Average weekly sales per supermarket were approximately $238,600 versus
$205,500 for the corresponding period of the prior year resulting in a 16.1%
increase. Same store sales for Canadian operations increased 7.3% from the
prior year while same store sales for U.S. operations increased 4.4% from
the prior year.
Gross margin as a percent of sales decreased 44 basis points to 28.40% from
28.84% for the prior year. Margins were negatively impacted due to
accelerated inventory markdowns in stores that were identified for closure
under Project Great Renewal and the exit of the Atlanta market during the
first quarter of fiscal 1999. The gross margin dollar decrease of $27
million resulted from a decrease in the gross margin rate of $18 million, a
decrease in sales volume of $5 million and a decrease in the Canadian
exchange rate of $4 million. The U.S. operations gross margin decrease of
$43 million resulted from a decrease in gross margin rate of $11 million and
a decrease of $32 million in sales volume. The Canadian operations gross
margin increase of $16 million resulted from an increase of $27 million in
sales volume, partially offset by a decrease of $7 million in gross margin
rate and a decrease of $4 million in the Canadian exchange rate.
Store operating, general and administrative expense increased $29.5 million
or 60 basis points to 28.09% from 27.49% compared to the corresponding
period of the prior year. The increase reflects charges relating to Project
Great Renewal and the exit of the Atlanta market during the first quarter of
fiscal 1999. Project Great Renewal charges consist of severance of $10
million which could not be accrued in fiscal 1998 because they did not meet
the criteria under EITF 94-3, store and facilities closure shut-down costs,
professional fees of $11 million associated with the implementation of the
store exit program and approximately $7 million for the conversion of
additional stores to the Food Basics format. The costs of exiting the
Atlanta market consist of severance of $6 million and store occupancy cost
of $11 million which relates principally to the present value of future
15
lease obligations, net of a $12 million gain that resulted from the
disposition of fixed and intangible assets.
Interest expense for the 28 weeks ended September 11, 1999 increased $5.5
million or 14.9% from the corresponding period of the prior year, primarily
due to the present value interest related to the future lease obligations of
the store exit and Atlanta exit programs as well as the issuance of $200
million 9.375% senior quarterly interest bonds on August 6, 1999.
Loss before income taxes for the 28 week period ended September 11, 1999 was
$22 million compared to income before income taxes of $40 million for the
comparable period in the prior year for a decrease of approximately $62
million. The loss is attributable principally to initiatives under the
Company's Project Great Renewal, exiting the Atlanta market in the first
quarter of fiscal 1999 and the increase in interest expense.
The income tax benefit recorded for the 28 week period of fiscal 1999
reflects the Company's estimated expected annual tax rates applied to its
respective domestic and foreign operations. The effective tax rate for the
28 week period of fiscal 1999 was 36.5%. The 28 week period of fiscal 1998
income tax provision mainly reflects taxes on U.S. income, as the Canadian
income tax expense was principally offset by the reversal of its deferred
tax asset valuation allowance. During the 28 week period of fiscal 1998,
the Canadian operations generated pretax earnings and reversed a portion of
the valuation allowance to the extent of the pretax earnings. The reversal
of the valuation allowance amounted to $7.7 million for the 28 week period
of fiscal 1998. Although Canada generated pretax earnings during the 28
week period of fiscal 1998, at September 12, 1998, the Company was unable to
conclude that the Canadian deferred tax assets were more likely than not to
be realized. This conclusion was based in part on Management's assessment
of the competitive Canadian marketplace and the level of the Canadian pretax
earnings, which for financial statement purposes is higher than the taxable
income for tax purposes due to differences between the financial statement
and income tax treatment of certain items. During the fourth quarter of
fiscal 1998, the Company determined that due to the actions taken as part of
its strategic initiatives under Project Great Renewal, it was more likely
than not that the deferred tax asset would be realized. Accordingly, the
Company reversed the remaining portion of the valuation allowance amounting
to approximately $60 million during the fourth quarter of fiscal 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company ended the second quarter with working capital of $56 million
compared to $90 million at the beginning of the fiscal year. The Company
had cash and short-term investments aggregating $144 million at the end of
the second quarter of fiscal 1999 compared to $137 million as of fiscal 1998
year end. Short-term investments were approximately $44 million and $25
million at September 11, 1999 and February 27, 1999, respectively, which
were primarily invested in commercial paper.
16
On August 6, 1999, the Company issued $200 million aggregate principal
amount 9.375% Senior Quarterly Interest Bonds due August 1, 2039. The
Company used the net proceeds from the issuance of the bonds to repay
borrowings under its revolving credit facility, to finance the purchase of
16 stores, (6 in the United States and 10 in Canada) and for working capital
and general corporate purposes.
The Company has an unsecured five year $499 million revolving credit
agreement (the "Credit Agreement") expiring June 10, 2002, with a syndicate
of banks, enabling it to borrow funds on a revolving basis sufficient to
refinance short-term borrowings. The Credit Agreement is comprised of the
U.S. credit agreement amounting to $465 million and the Canadian credit
agreement amounting to C$50 million (U.S. $34 million at September 11,
1999). As of September 11, 1999, there were no outstanding borrowings under
the Credit Agreement. Accordingly, as of September 11, 1999, the Company
had $499 million available under the Credit Agreement. Borrowings under the
agreement during the 28 week period were subject to interest at the weighted
average rate of 5.4% based upon the variable LIBOR pricing.
In addition to the Credit Agreement, the Company has various uncommitted
lines of credit with several banks. As of September 11, 1999, the Company
had $179 million available in uncommitted lines of credit.
There were no outstanding borrowings of uncommitted lines of credit as of
September 11, 1999.
The Company's Credit Agreement and certain of its notes contain various
financial covenants which require, among other things, minimum net worth and
maximum levels of indebtedness and lease commitments. The Company was in
compliance with all such covenants as of September 11, 1999.
The Company's existing senior debt rating was Ba1 with Moody's Investors
Service and BBB- with Standard & Poor's Ratings Group as of September 11,
1999. Rating changes could affect the availability and cost of financing to
the Company.
For the 28 weeks ended September 11, 1999, capital expenditures totaled $257
million, which included 18 new stores and 39 remodels and enlargements.
Currently, the Company expects to achieve its fiscal 1999 planned capital
expenditures of approximately $500 million. Accordingly, the Company
expects to have capital expenditures of approximately $243 million
throughout the remainder of fiscal 1999.
These available cash resources, together with cash generated from
operations, are sufficient for the Company's capital expenditure program,
mandatory scheduled debt repayments and dividend payments for fiscal 1999.
17
MARKET RISK
Market risk represents the risk of loss that may impact the consolidated
financial position, results of operations or cash flows of the Company. The
Company is exposed to market risk in the areas of interest rates and foreign
currency exchange rates.
Interest rates
The Company's exposure to market risk for changes in interest rates relates
primarily to the Company's debt obligations. The Company has no cash flow
exposure due to rate changes on its $775 million in notes as of September 11,
1999 and $575 million as of February 27, 1999. However, the Company does
have cash flow exposure on its committed and uncommitted bank
lines of credit due to its variable LIBOR pricing. As of September 11, 1999,
there were no outstanding borrowings subject to interest rate fluctuations.
Foreign Exchange Risk
The Company is exposed to foreign exchange risk to the extent of adverse
fluctuations in the Canadian dollar. Based upon historical Canadian currency
movement, the Company does not believe that reasonably possible near-term
change in the Canadian currency of 10% will result in a material effect on
future earnings, financial position or cash flows of the Company.
The Company entered into a five year cross-currency swap agreement to hedge
five year notes in Canada that are denominated in U.S. dollars. The Company
does not have any currency risk regarding the Canadian five year notes. The
Company is exposed to currency risk in the event of default by the
counterparty. Such default is remote, as the counterparty is a widely
recognized and reputable investment banker. The fair value of the cross-
currency swap agreement was favorable to the Company by $6.3 million and $6.9
million as of September 11, 1999 and February 27, 1999, respectively. A 10%
change in the Canadian exchange rates would have resulted in the fair value
fluctuating approximately $6.8 million at September 11, 1999 and $6.6 million
at September 12, 1998.
18
YEAR 2000 COMPLIANCE
The Company has formed an ongoing task force to review the entire range of
the Company's operations relating to Year 2000 issues. This task force
reports to the Vice Chairman of the Board of Directors. Assessment of those
functions of the business that require attention and resources to achieve
Year 2000 compliance is in progress throughout the entire organization. The
Information Technology ("IT") and non-IT areas assessment is complete. The
current estimate of the remediation effort (including new programs and
components) is approximately 90% complete in the IT area and 95% in the non-
IT area. Testing of the systems and implementation of renovated and new
systems are currently in progress. A number of renovated and new systems
that are Year 2000 compliant are currently being used in operations.
The costs to address the Company's Year 2000 issues are estimated to be
approximately $10 million. Approximately $7.5 million of these costs have
been incurred as of September 11, 1999. Some IT projects have been deferred
due to the Year 2000 project, however, the Company believes that such a
deferral will not affect the Company's financial performance.
The task force is responsible for assessing, from an IT perspective, the
extent of affected software/hardware and developing procedures to resolve the
potential problems associated with that software/hardware. The procedures
developed include making the necessary changes to the affected software,
adequately testing the changes and phasing in the Year 2000 compliant
programs to limit disruption or delay in the Company's normal business
activities. The Company is also in the process of updating vendor software
packages to the latest versions to insure all Company software is Year 2000
compliant. Some in-store IT systems, as well as other support area IT
systems, have been remediated to be Year 2000 ready.
The risks of Year 2000 issues from a non-IT area are principally as follows:
electrical outages resulting in breakdown of point of sale systems, lighting
and refrigeration equipment and the loss of utility service. The Company has
inventoried equipment with potential embedded chips and is in the process of
replacing the affected chips or microprocessors, or purchasing new equipment
that is compliant. This process is substantially complete with full
completion expected by the end of October 1999. The Company plans to
mitigate the potential effect of such issues by preparing a contingency plan
as discussed below.
Significant risk also arises out of the possible failure of vendors to
respond to Year 2000 issues. The Company has met with its major vendors and
suppliers to determine their state of readiness and to review the contingency
plans that they have developed. Companies that are compliant and have
prepared for contingencies have a status as preferred suppliers. With
respect to other vendors that either are not Year 2000 compliant or do not
have adequate contingency or remediation plans, the Company will seek
alternative sources when possible.
19
With respect to contingencies, a program has been developed to identify the
additional resources that will be necessary to fully run the Company when and
if it is affected by the foregoing risk factors. The Company will continue to
expand its contingency plans and detailed procedures in order to mitigate the
effects of the Year 2000 issues that might affect the Company.
The Company believes that it has allocated sufficient resources to resolve
all significant Year 2000 issues in a timely manner. Accordingly, the Company
plans for all critical systems to be Year 2000 ready by the end of October
1999.
CAUTIONARY NOTE
This report contains certain forward-looking statements about the future
performance of the Company which are based on Management's assumptions and
beliefs in light of the information currently available to it. The Company
assumes no obligation to update the information contained herein. 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 the Company's principal markets; the
Company's relationships with its employees and the terms of future collective
bargaining agreements; the costs and other effects of legal and
administrative cases and proceedings; the nature and extent of continued
consolidation in the food industry; changes in the financial markets which
may affect the Company's cost of capital and the ability of the Company to
access the public debt and equity markets to refinance indebtedness and fund
the Company's capital expenditure program on satisfactory terms; supply or
quality control problems with the Company's vendors; changes in economic
conditions which affect the buying patterns of the Company's customers; and
the ability of the Company and its vendors, financial institutions and others
to resolve Year 2000 processing issues in a timely manner.
20
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
PART II. OTHER INFORMATION
---------------------------
Item 1. Legal Proceedings
-----------------
The action entitled Shirley A. Lang, et al. V. Kohl's Food Stores,
Inc. and The Great Atlantic & Pacific Tea Company, Inc., was tried
to a Madison, Wisconsin jury during the week commencing August 9,
1999. The issue before the jury was the alleged violation of the
Federal Equal Pay Act stemming from the complaint that Kohl's
produce clerk and produce manager positions allegedly pay more than
Kohl's bakery and deli clerk and manager positions, but allegedly
require no greater skill than the produce positions. The
plaintiffs sought lost wages, punitive damages and other benefits,
costs and attorney's fees and other relief. In July the court had
granted summary judgment to the defendants in respect of the
alleged violations of the Civil Rights Act of 1964 ("Title VII"),
arising out of the same produce/bakery deli pay differential
allegations.
On August 13, 1999, the jury returned a unanimous verdict in favor
of the defendants (i.e., the Company and its Kohl's Food Stores,
Inc. subsidiary). An appeal has been filed, but the Company
expects to prevail on the appeal.
Item 2. Changes in Securities
---------------------
None
Item 3. Defaults Upon Senior Securities
-------------------------------
None
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
None - Matters were previously reported in the first quarter ended
June 19, 1999, Form 10-Q report filed with the Commission.
Item 5. Other Information
-----------------
On June 9, 1999, The Company and its Trusts, (A&P Finance I, A&P
Finance II and A&P Finance III) filed with the Securities and
Exchange Commission, a registration statement (Registration #333)
on form S-3 under the Securities Act of 1933. Such filed
information with respect to the trusts' preferred trust securities
is herewith incorporated by reference.
21
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
On August 11, 1999, the Company filed Form 8-K with the Securities
and Exchange Commission with respect to the Underwriting Agreement
dated August 6, 1999 among The Great Atlantic & Pacific Tea
Company, Inc., Morgan Stanley & Co. Inc., Salomon Smith Barney
Inc., Dain Raucher Wessels and Everen Securities, Inc., relating to
the issuance of $200,000,000 aggregate principal amount of 9.375%
Senior Quarterly Interest Bonds due August 1, 2039. Such filed
information is herewith incorporated by reference.
22
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.
Date: October 22, 1999 By: /s/ Kenneth A. Uhl
---------------------------------------
Kenneth A. Uhl, Vice President and
Controller (Chief Accounting Officer)
23
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