Conformed Copy
FORM 10-Q
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 December 5, 1998 Commission File Number 1-4141
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
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(Exact name of registrant as specified in charter)
Maryland 13-1890974
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(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
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- ----------------------------------------------------------------------------
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
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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 December 5, 1998
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Common stock - $1 par value 38,286,716 shares
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
STATEMENTS OF CONSOLIDATED OPERATIONS & RETAINED EARNINGS
(Dollars in thousands, except share amounts)
(Unaudited)
12 Weeks Ended 40 Weeks Ended
Dec. 5, Nov. 29, Dec. 5, Nov. 29,
1998 1997 1998 1997
----------- ----------- ----------- -----------
Sales $ 2,344,400 $2,318,821 $ 7,753,035 $7,759,107
Cost of merchandise sold (1,664,686) (1,655,094) (5,513,730) (5,537,697)
---------- ---------- ---------- ----------
Gross margin 679,714 663,727 2,239,305 2,221,410
Store operating, general and
administrative expense (681,463) (632,974) (2,168,170) (2,099,011)
---------- ---------- ---------- ----------
Income (loss)from operations (1,749) 30,753 71,135 122,399
Interest expense (16,212) (18,670) (53,025) (62,016)
Interest income 1,549 1,526 5,186 5,831
---------- ---------- ---------- ----------
Income (loss) before income
taxes (16,412) 13,609 23,296 66,214
Benefit (provision) for income
taxes 7,678 (2,375) (1,910) (15,986)
---------- ---------- ---------- ----------
Income (loss)before
extraordinary item (8,734) 11,324 21,386 50,228
Extraordinary loss on early
extinguishment of debt
(net of income tax benefit
of $394) - - - (544)
---------- ---------- ---------- ----------
Net income (loss) (8,734) 11,234 21,386 49,684
Retained earnings at
beginning of period 517,976 478,568 495,510 447,768
Cash dividends (3,829) (3,825) (11,483) (11,475)
---------- ---------- ---------- ----------
Retained earnings at
end of period $ 505,413 $ 485,977 $ 505,413 $ 485,977
========== ========== ========== ==========
Basic earnings (loss)
per share:
Income (loss) before extra-
ordinary item $ (.23) $ .29 $ .56 $ 1.31
Extraordinary loss on early
extinguishment of debt - - - (.01)
---------- ---------- ---------- ----------
Net income (loss) per
share - basic $ (.23) $ .29 $ .56 $ 1.30
========== ========== ========== ==========
Diluted earnings (loss)
per share:
Income (loss) before extra-
ordinary item $ (.23) $ .29 $ .56 $ 1.31
Extraordinary loss on early
extinguishment of debt - - - (.01)
---------- ---------- ---------- ----------
Net income (loss) per share -
diluted $ (.23) $ .29 $ .56 $ 1.30
========== ========== ========== ==========
Cash dividends $ .10 $ .10 $ .30 $ .30
========== ========== ========== ==========
Weighted average number of
common shares outstanding 38,306,716 38,250,371 38,289,616 38,249,395
Common stock equivalents 2,863 86,733 35,109 9,674
---------- ---------- ---------- ----------
Weighted average number of
common and common
equivalent shares
outstanding 38,309,579 38,337,104 38,324,725 38,259,069
========== ========== ========== ==========
See Notes to Quarterly Report on Page 5.
Page 1
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
CONSOLIDATED BALANCE SHEETS
---------------------------
(Dollars in thousands)
Dec. 5, 1998 Feb 28, 1998
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(Unaudited)
ASSETS
- ------
Current assets:
Cash and short-term investments $138,949 $ 70,937
Accounts receivable 214,169 227,703
Inventories 946,077 882,229
Prepaid expenses and other assets 38,235 36,358
---------- ----------
Total current assets 1,337,430 1,217,227
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Property:
Property owned 1,604,145 1,506,819
Property leased 86,219 90,058
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Property-net 1,690,364 1,596,877
Other assets 175,912 181,149
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Total assets $3,203,706 $2,995,253
========== ==========
See Notes to Quarterly Report on Page 5.
Page 2
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
CONSOLIDATED BALANCE SHEETS
---------------------------
(Dollars in thousands)
Dec. 5, 1998 Feb. 28, 1998
------------ -------------
(Unaudited)
LIABILITIES & SHAREHOLDERS' EQUITY
- ----------------------------------
Current liabilities:
Current portion of long-term debt $ 5,489 $ 16,824
Current portion of obligations under
capital leases 11,728 12,293
Accounts payable 542,271 441,149
Book overdrafts 154,305 151,846
Accrued salaries, wages and benefits 151,154 146,064
Accrued taxes 61,597 57,856
Other accruals 123,732 129,098
---------- ----------
Total current liabilities 1,050,276 955,130
---------- ----------
Long-term debt 796,262 695,292
---------- ----------
Obligations under capital leases 114,035 120,980
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Deferred income taxes 119,374 120,618
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Other non-current liabilities 199,334 176,601
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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 38,286,716 and 38,252,966,
respectively 38,287 38,253
Capital surplus 454,848 453,894
Cumulative translation adjustment (67,913) (54,815)
Minimum pension liability adjustment (6,210) (6,210)
Retained earnings 505,413 495,510
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Total shareholders' equity 924,425 926,632
---------- ----------
Total liabilities and shareholders'
equity $3,203,706 $2,995,253
========== ==========
See Notes to Quarterly Report on Page 5.
Page 3
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
40 Weeks Ended
Dec. 5, 1998 Nov. 29, 1997
-------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 21,386 $ 49,684
Adjustment to reconcile net income
to cash provided by operating activities:
Depreciation and amortization 181,442 179,165
Deferred income tax (benefit) provision (3,249) 7,047
(Gain) on disposal of owned property
and write-down of property, net 3,939 (7,666)
(Increase) decrease in receivables 9,386 (24,853)
Increase in inventories (72,706) (60,826)
(Increase) decrease in prepaid expenses
and other current assets 2,336 (575)
(Increase) decrease in other assets 4,826 (5,872)
Increase in accounts payable 108,858 23,113
Increase(decrease) in accrued salaries,
wages and benefits 1,432 (6,229)
Increase in accrued taxes 4,125 8,556
Increase in other accruals
and other liabilities 36,690 8,956
Other operating activities, net (3,188) (1,525)
--------- ---------
Net cash provided by operating activities 295,277 168,975
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CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for property (307,875) (204,104)
Proceeds from disposal of property 6,297 17,840
--------- ---------
Net cash used in investing activities (301,578) (186,264)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Changes in short-term debt (22,500) (38,000)
Proceeds under revolving lines of credit 415,000 647,148
Payments on revolving lines of credit (300,000) (777,118)
Proceeds from long-term borrowings 3,642 301,523
Payments on long-term borrowings (6,507) (30,678)
Decrease in book overdrafts 7,098 13,177
Principal payments on capital leases (9,274) (9,522)
Deferred financing fees - (2,532)
Cash dividends (11,483) (11,475)
Proceeds from stock options exercised 988 93
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Net cash provided by financing activities 76,964 92,616
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Effect of exchange rate changes on
cash and short-term investments (2,651) (1,659)
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NET INCREASE IN CASH AND
SHORT-TERM INVESTMENTS 68,012 73,668
Cash and Short-Term Investments
at Beginning of Period 70,937 98,830
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CASH AND SHORT-TERM INVESTMENTS
AT END OF PERIOD $ 138,949 $ 172,498
========= =========
See Notes to Quarterly Report on Page 5.
Page 4
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
NOTES TO QUARTERLY REPORT
-------------------------
1) BASIS OF PRESENTATION
The consolidated financial statements for the 40 weeks ended December 5,
1998 and November 29, 1997 are unaudited, and in the opinion of
management, all adjustments necessary for a fair presentation of such
financial statements have been included. Such adjustments consisted only
of normal recurring items. 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 1997 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 40 week period ended in fiscal
years 1998 and 1997 reflect the Company's estimated expected annual tax
rates applied to their respective domestic and foreign financial results.
For the 40 week period ended in fiscal years 1998 and 1997, the income
tax provisions mainly reflect taxes on U.S. income, as the Canadian
income tax expense is principally offset by the reversal of its deferred
tax asset valuation allowance. During the 40 week period ended in fiscal
years 1998 and 1997, 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
$8.9 million and $12.6 million for the 40 week period ended in fiscal
years 1998 and 1997, respectively. Although Canada generated pretax
earnings, 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. This is of further significance since
the largest portion of the Canadian deferred tax asset relates to net
operating loss carryforwards which expire between fiscal 1999 and fiscal
2002. The positive evidence that Management believes is necessary in
order to reverse some or all of the Canadian deferred tax asset valuation
allowance includes a trend in earnings to a level which would allow
Management to conclude that it is more likely than not that a portion or
all of the deferred tax assets would be realized. However, as noted in
Footnote 7 Subsequent Event herein, the Company will reverse the valuation
allowance as a result of the actions described therein during the fourth
quarter of fiscal 1998.
PAGE 5
3) FOOD BASICS FRANCHISING
As of December 5, 1998, the Company served 55 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 $296 million and $252
million for the 40 week period ended in fiscal years 1998 and 1997,
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.
Included in other assets are Food Basics franchising business
receivables, net of allowance for doubtful accounts, amounting to
approximately $33 million and $38 million at December 5, 1998 and
February 28, 1998, 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 million are included in accounts receivable at December
5, 1998 and February 28, 1998.
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) EXTRAORDINARY ITEM
During the second quarter of fiscal 1997, the Company retired at a
premium of approximately $0.9 million, mortgages amounting to $20 million
with an effective interest rate of 9.44%.
5) WRITE-DOWN OF PROPERTY
During the third quarter of fiscal 1998, the Company made a decision to
no longer proceed with a future store site. Accordingly, in the third
quarter of fiscal 1998 the Company recorded a charge of approximately $7
million to write-down the property to its fair market value.
6) NEW ACCOUNTING PRONOUNCEMENTS
Effective March 1, 1998 the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." This
Statement requires that all components of comprehensive income be
reported prominently in the financial statements. Currently, the Company
has other comprehensive income relating to foreign currency translation
adjustment. The Company's total comprehensive income is as follows (in
thousands):
12 Weeks Ended 40 Weeks Ended
Dec. 5, Nov. 29, Dec. 5, Nov. 29,
1998 1997 1998 1997
-------- -------- ------- --------
Net income $ (8,734) $11,234 $21,386 $49,684
Foreign currency translation
adjustment (2,114) (5,518) (13,098) (6,188)
-------- ------- ------- -------
Total comprehensive income
(loss) $(10,848) $ 5,716 $ 8,288 $43,496
========= ======= ======= =======
PAGE 6
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards 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. The Company is currently studying the effects of SFAS 133
on its cross-currency and interest rate swaps and expects to adopt SFAS
133 in fiscal 2000.
7) SUBSEQUENT EVENT
On December 8, 1998, the Company's Board of Directors approved a plan to
exit 127 non-strategic, underperforming store locations throughout the
U.S. and Canada and the further consolidation of distribution and
administrative functions. As a result of the exit program, in the fourth
quarter ending February 27, 1999, the Company will record as part of
store operating, general, and administrative expense an after-tax charge
in the range of $120 to $160 million associated with the lease
obligations and write-down of fixed assets related to the stores
identified and other charges in the Company's exit program.
In conjunction with the actions to be taken relating to Canada as part of
this strategic initiative and exit program the Company will reverse the
Canadian subsidiary's deferred tax asset valuation allowance. This
conclusion was reached due to the elimination of the losses that were
generated by the underperforming stores which results in the remaining
operations being profitable at a level which enables Management to
conclude that it is more likely than not that the deferred tax assets
will be realized. Accordingly, in the fourth quarter ending February 27,
1999, the Company will record a tax benefit of approximately $60 million,
reversing the deferred tax asset valuation allowance originally recorded
in fiscal 1994.
As a result of the fourth quarter charges, the Company will not be in
compliance, as of February 27, 1999, with certain financial covenants of
the unsecured five year $498 million revolving credit agreement expiring
June 10, 2002 (the "Credit Agreement"). The Company has been in
discussion with its banks in order to obtain the necessary waivers of the
covenants. Although there is no assurance, the Company expects to obtain
the waivers prior to February 27, 1999. The Company believes that the
costs of the waivers will not have a material impact on the Company's
statement of operations or the statement of position.
As of December 5, 1998, the Company was in compliance with all covenants
relating the Credit Agreement and other notes.
PAGE 7
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 DECEMBER 5, 1998
--------------------------------
OPERATING RESULTS
Sales for the third quarter ended December 5, 1998 of $2.34 billion
increased $26 million or 1.1% from the prior year third quarter amount. The
opening of 19 stores in new locations, excluding replacement stores, since
the third quarter of fiscal 1997 added approximately $59 million or 2.5% to
sales in the third quarter of fiscal 1998. In addition, wholesale sales to
the Food Basics franchised stores increased $10 million or 12.2% to $89
million for the 12 weeks ended December 5, 1998. These increases were
offset by the closure of 53 stores, excluding replacement stores, since the
beginning of the third quarter of fiscal 1997, which reduced total sales by
approximately $60 million or 2.6% in the third quarter of fiscal 1998. A
decrease in the Canadian exchange rate reduced third quarter fiscal 1998
sales by $44 million or 1.9%. In addition, same store sales ("same store
sales" referred to herein include replacement stores) increased 2.6% or $55
million from the same period last year.
Average weekly sales per supermarket were approximately $209,600 versus
$200,100 for the corresponding period of the prior year resulting in a 4.7%
increase. Same store sales for Canadian operations increased 5.3% from the
prior year and same store sales for U.S. operations increased 2.1% from the
prior year.
Gross margin as a percent of sales increased 37 basis points to 28.99% in
the third quarter of fiscal 1998 from 28.62% for the third quarter of fiscal
1997, resulting primarily from a better product mix of higher margin items
coupled with a margin recovery at our Waldbaum's group. The gross margin
dollar increase of $16 million resulted from an increase in the gross margin
rate of $8 million and an increase in sales volume of $18 million, both of
which were partially offset by a decrease in the Canadian exchange rate of
$10 million. The U.S. operations accounted for an increase of $21 million
in gross margin rate. The gross margin rate increased by $13 million and
sales volume increased by $8 million. The Canadian operations accounted for
a decrease of $5 million in gross margin. A decrease of $5 million in gross
margin rate and a decrease of $10 million in the Canadian exchange rate were
partially offset by an increase of $10 million in sales volume.
Store operating, general, and administrative expense increased $49 million
or 177 basis points to 29.07% from 27.30% for the corresponding period of
the prior year. This increase reflects a charge for the closing of two
warehouses, a bakery and a coffee plant and buy-outs of a number of store
employees. In addition, the Company consolidated administrative functions
in the Northeast and the management of the two Super Fresh divisions.
During the quarter the Company also wrote-down a property no longer held for
a potential store site and incurred professional fees relating to the
Company's overall strategic program. The charge to cover the items noted
above amounted to approximately $27 million. The $27 million in charges are
detailed as follows: exit costs relating to the closure of the warehouses,
bakery and the coffee plant amounted to approximately $4 million, of which
approximately $1 million has been incurred or paid; severance and employee
buy-out costs of approximately $11 million of which approximately $5 million
has been paid; costs incurred in the third quarter to close the warehouses
and coffee plant and consulting fees resulting from the Company's strategic
initiatives amounted to approximately $5 million; and the property write-
down amounted to approximately $7 million. Further the Company incurred $4
million of higher store closing costs than the prior year as a result of the
accelerated store modernization program. Excluding these charges amounting
to $31 million, store operating, general and administrative expense
increased approximately $18 million or 46 basis points to 27.76% from 27.30%
for the corresponding period of the prior year. The $18 million increase is
primarily due to an increase in occupancy costs of the new generation
superstores coupled with higher advertising expense.
PAGE 8
Interest expense decreased $2 million or 13.2% from the corresponding period
of the previous year, primarily due to a decrease in average debt
outstanding of approximately $50 million for the third quarter of fiscal
1998 as compared to the third quarter of fiscal 1997.
Interest income of approximately $2 million approximated the prior year
amount.
Loss before income taxes for the third quarter ended December 5, 1998 was
$16 million compared to income of $14 million for the comparable period in
the prior year for a decrease of approximately $30 million. Included in the
third quarter results for the current year are $27 million of store
operating general and administrative charges discussed above and $4 million
of higher store closing costs. Excluding these amounts which total $31
million, income before income taxes for the 12 week period ended December 5,
1998 would have been $14 million which approximated the prior year amount
and was comprised of higher gross margin of $16 million and lower interest
expense of $2 million, fully offset by higher store operating, general and
administrative expense of $18 million.
The income tax benefit recorded in the third quarter of fiscal 1998 reflects
the benefit on the loss generated by the U.S. operations as the Canadian
operations income tax provision was principally offset by the reversal of
the deferred tax asset valuation allowance. The effective tax rate for the
third quarter of fiscal 1997 was 17.5%. The third quarter fiscal 1997
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 third quarter of fiscal 1998 and 1997
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 $1.2 million and $3.7 million for the
12 week period of fiscal years 1998 and 1997, respectively. The valuation
allowance reversal for the 40 week period of fiscal years 1998 and 1997
amounted to $8.9 million and $12.6 million, respectively. Although Canada
generated pretax earnings, 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. This is of further significance since the
largest portion of the Canadian deferred tax asset relates to net operating
loss carryforwards which expire between fiscal 1999 and fiscal 2002. The
positive evidence that Management believes is necessary in order to reverse
some or all of the Canadian deferred tax asset valuation allowance includes
a trend in earnings to a level which would allow Management to conclude that
it is more likely than not that a portion or all of the deferred tax assets
would be realized. During the fourth quarter, the Company has determined
that due to the actions to be taken as part of its strategic initiatives
(see Note 7 Subsequent Events in the Financial Statements) it is more likely
than not that the deferred tax asset will be realized. Accordingly, the
Company will reverse the valuation allowance during the fourth quarter of
fiscal 1998.
PAGE 9
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
40 WEEKS ENDED DECEMBER 5, 1998
------------------------------------------------
OPERATING RESULTS
Sales for the 40 weeks ended December 5, 1998 of $7.75 billion decreased $6
million or 0.1% from the prior year. The opening of 30 stores in new
locations, excluding replacement stores, since the beginning of the third
quarter of fiscal 1997 added approximately $163 million or 2.1% to sales in
the 40 week period of fiscal 1998. In addition, wholesale sales to the Food
Basics franchised stores increased $44 million or 17.4% to $296 million for
the 40 week period ended December 5, 1998. These increases were partially
offset by the closure of 95 stores, excluding replacement stores, since the
beginning of fiscal 1997, of which 11 have been sold in the Carolina market,
which reduced total sales by approximately $203 million or 2.6% in the 40
week period of fiscal 1998. A decrease in the Canadian exchange rate
reduced sales by $104 million or 1.3% in the 40 week period of fiscal 1998.
In addition, same store sales ("same store sales" referred to herein include
replacement stores) increased 1.1% or $78 million from the same period last
year.
Average weekly sales per supermarket were approximately $206,600 versus
$198,800 for the corresponding period of the prior year resulting in a 3.9%
increase. Same store sales for Canadian operations increased 4.4% from the
prior year and same store sales for U.S. operations increased 0.5% from the
prior year.
Gross margin as a percent of sales increased 25 basis points to 28.88% from
28.63% for the prior year, resulting primarily from a better product mix of
higher margin items coupled with a margin recovery at our Waldbaums group.
The gross margin dollar increase of $18 million resulted from an increase in
the gross margin rate of $20 million and an increase in sales volume of $23
million, both of which were partially offset by a decrease in the Canadian
exchange rate of $25 million. The U.S. operations accounted for $23 million
gross margin increase as the increase in the gross margin rate of $27
million was partially offset by a sales volume decrease which reduced gross
margin by $4 million. The Canadian operations accounted for a decrease of
$5 million in gross margin. A decrease of $7 million in gross margin rate
and a decrease of $25 million in the Canadian exchange rate were partially
offset by an increase of $27 million in sales volume.
Store operating, general, and administrative expense increased $69 million
or 92 basis points to 27.97% from 27.05% for the prior year. Included in
store operating, general and administrative expenses is a second quarter
litigation charge of $4 million coupled third quarter charges for the
closing of two warehouses, a bakery and a coffee plant and buy-outs of a
number of store employees. In addition, the Company consolidated
administrative functions in the Northeast and the management of the two
Super Fresh divisions. During the third quarter the Company also wrote-down
a property no longer held for a potential store site and incurred
professional fees relating to the overall strategic program. The third
quarter charge relating to the items noted above amounted to approximately
$27 million. Further, for the 40 week period ended December 5, 1998, the
Company incurred $12 million of higher store closing costs than the prior
year as a result of the accelerated store modernization program. Excluding
the third quarter charges noted above amounting to $27 million, the
litigation charge of $4 million, and the higher store closing costs of $12
million; store operating, general, and administrative expense increased $26
million or 36 basis points to 27.41% from 27.05% for the corresponding
period of the prior year. This increase is primarily due to an increase in
store occupancy costs of the new generation superstores coupled with higher
advertising expense.
PAGE 10
Interest expense decreased $9 million or 14.5% from the previous year,
primarily due to a decrease in average debt outstanding of $69 million for
the 40 week period of fiscal 1998 as compared to the prior year.
Interest income of approximately $5 million approximated the prior year
amount.
Income before income taxes for the 40 week period ended December 5, 1998 was
$23 million compared to $66 million for the comparable period in the prior
year for a decrease of approximately $43 million or 65%. Excluding the
third quarter charges noted above of $27 million, the litigation charge and
the higher store closing costs, income before income taxes for the 40 week
period ended December 5, 1998 would have been approximately $66 million
which approximated the prior year amount and was comprised of higher gross
margin of $18 million and lower interest expense of $9 million, fully offset
by higher store operating, general and administrative expense of $27
million.
Recent Developments
On December 8, 1998, the Company's Board of Directors approved a plan to
exit 127 non-strategic, underperforming store locations throughout the U.S.
and Canada and the further consolidation of distribution and administrative
functions. As a result of the exit program, in the fourth quarter ending
February 27, 1999, the Company will record as part of store operating,
general, and administrative expense an after-tax charge in the range of $120
to $160 million associated with the lease obligations and write-down of
fixed assets related to the stores identified and other charges in the
Company's exit program.
In conjunction with the actions to be taken relating to Canada as part of
this strategic initiative and exit program the Company will reverse the
Canadian subsidiary's deferred tax asset valuation allowance. This
conclusion was reached due to the elimination of the losses that were
generated by the underperforming stores which results in the remaining
operations being profitable at a level which enables management to conclude
that it is more likely than not that the deferred tax assets will be
realized. Accordingly, in the fourth quarter ending February 27, 1999,
the Company will record a tax benefit of approximately $60 million,
reversing the deferred tax asset valuation allowance originally recorded in
fiscal 1994.
LIQUIDITY AND CAPITAL RESOURCES
The Company ended the third quarter with working capital of $287 million
compared to $262 million at the beginning of the fiscal year. The Company
had cash and short-term investments aggregating $139 million at the end of
the third quarter of fiscal 1998 compared to $71 million as of fiscal 1997
year end. Short-term investments were approximately $27 million and $20
million at December 5, 1998 and February 28, 1998, respectively, which were
primarily invested in commercial paper.
The Company has an unsecured five year $498 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. $33 million at December 5, 1998).
As of December 5, 1998, the Company had $205 million outstanding against the
Credit Agreement. Accordingly, as of December 5, 1998, the Company had $293
million available under the Credit Agreement.
PAGE 11
In addition to the Credit Agreement, the Company also has various
uncommitted lines of credit with numerous banks. As of December 5, 1998,
the Company had $15 million outstanding on the uncommitted lines of credit.
The Company has an additional $206 million available in uncommitted lines of
credit as of December 5, 1998.
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 December 5, 1998. However, as a
result of the Company's plan to exit 127 stores beginning in the fourth
quarter ending February 27, 1999, the Company will not be in compliance with
certain financial covenants of the Credit Agreement for the quarter ending
February 27, 1999. The Company has been in discussion with its banks in
order to obtain the necessary waivers of the covenants. Although there is
no assurance, the Company expects to obtain the waivers prior to February
27, 1999. The Company believes that the costs of the waivers will not have
a material impact on the Company's statement of operations or the statement
of position.
On July 1, 1998, Moody's Investor's Service downgraded the Company's
existing senior debt rating to Ba1 from Baa3. The Company's rating from
Standard & Poor's remained unchanged from the fiscal year end rating of
BBB-. Rating changes could affect the availability and cost of financing to
the Company.
For the 40 weeks ended December 5, 1998, the net cash used in investing
activities totaled $302 million. This included capital expenditures of $308
million, which included 30 new stores and 54 remodels and enlargements.
Currently, the Company projects that total cash used in investing activities
for fiscal 1998 will amount to approximately $360 million. Accordingly, the
Company expects to have cash outlays relating to investing activities of
approximately $52 million throughout the remainder of fiscal 1998.
These available cash resources, assuming that waivers are obtained as
anticipated, together with income from operations, are sufficient for the
Company's capital expenditure program, mandatory scheduled debt repayments
and dividend payments for fiscal 1998 and fiscal 1999.
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") assessment is complete and the non-IT areas are
approximately 25% complete. The current estimate of the remediation effort
(including new programs and components) is approximately 60% complete in the
IT area and has commenced 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.
PAGE 12
The costs to address the Company's Year 2000 issues are estimated to be
approximately $5 million. Approximately $2.2 million of these costs have
been incurred from 1997 through the third quarter of 1998. In addition, the
Company will incur additional capital expenditures of approximately $5
million for new equipment during the remainder of fiscal 1998 and fiscal 1999
that is Year 2000 compliant. 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.
From an IT perspective, the task force is responsible for assessing 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 will also need remediation to become Year 2000 compliant.
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. In addition,
certain store equipment may have imbedded chips or microprocessors that are
not Year 2000 compliant. The Company is in the process of identifying such
equipment and either replacing the affected chips or microprocessors or
purchasing new equipment that is compliant. The events noted above could
severely affect Company operations. 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 is meeting 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 will 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.
With respect to contingencies, a program is being 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. Over the next year, 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 to be Year 2000 compliant by October 1999.
PAGE 13
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: the success of Company's strategic
initiatives and store exit program; 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.
PAGE 14
THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC.
PART II. OTHER INFORMATION
---------------------------
Item 1. Legal Proceedings
-----------------
On August 28, 1998 Capital Graphics Advertising Agency, Inc.
("Capital Graphics") was awarded a verdict against the Company
amounting to $4 million. This lawsuit is the result of the Company
terminating a relationship with an Atlanta printer which the
Company felt that it had a right to terminate. However, a jury
awarded Capital Graphics damages, plus interest and litigation
expenses totaling $4 million. The Company believes that it has
several strong bases for the appellate court to set aside the
jury's verdict and order a new trial. Accordingly, the Company
will proceed with an appeal and defend against this claim
vigorously.
Item 2. Changes in Securities
---------------------
None
Item 3. Defaults Upon Senior Securities
-------------------------------
None
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
None
Item 5. Other Information
-----------------
None
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
On December 9, 1998, Form 8-K was filed with the Securities and
Exchange Commission with regard to the Company's December 8, 1998
announcement relating to the Company's strategic initiatives. The
major elements of these initiatives include plans to close 127 non-
strategic stores; to realign and consolidate distribution and
manufacturing facilities and administrative functions; to reduce
working capital and to dispose of other non-strategic assets.
Page 15
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: January 19, 1999 By: /s/ Kenneth A. Uhl
---------------------------------------
Kenneth A. Uhl, Vice President and
Controller (Chief Accounting Officer)
Page 16
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