<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended For the 12 Weeks Ended June 14, 1997
------------------------------------
- -- TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________________ to _________________
Commission file number: 0-15590
-------
QUALITY FOOD CENTERS, INC.
-----------------------------------------------------
(Exact name of registrant as specified in its charter)
Washington 91-1330075
- --------------------------------- --------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10112 N.E. 10th Street, Bellevue, Washington 98004
- -------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(206) 455-3761
----------------------------------------------------
(Registrant's telephone number, including area code)
Not applicable.
-----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X . No .
---- ---
Number of shares of Registrant's common stock, $.001 par value, outstanding
at July 18, 1997: 20,968,598
<PAGE>
PART I. FINANCIAL INFORMATION
QUALITY FOOD CENTERS, INC.
CONSOLIDATED STATEMENTS OF EARNINGS
(unaudited)
(in thousands, except per share data)
<TABLE>
<CAPTION>
TWELVE WEEKS ENDED 24 WEEKS ENDED
---------------------- ----------------------
JUNE 14, JUNE 15, JUNE 14, JUNE 15,
1997 1996 1997 1996
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Sales............................................... $ 501,128 $ 184,397 $ 734,282 $ 361,024
Cost of sales and related occupancy expenses........ 380,674 138,221 555,587 271,534
Marketing, general and administrative expenses...... 96,448 34,522 141,822 68,008
---------- ---------- ---------- ----------
OPERATING INCOME.................................... 24,006 11,654 36,873 21,482
Interest income..................................... 704 112 893 184
Interest expense.................................... (7,990) (2,165) (10,767) (4,753)
---------- ---------- ---------- ----------
EARNINGS BEFORE INCOME TAXES........................ 16,720 9,601 26,999 16,913
Taxes on income
Current............................................. 7,358 3,002 10,917 5,225
Deferred............................................ (400) 432 (100) 838
---------- ---------- ---------- ----------
Total taxes on income............................... 6,958 3,434 10,817 6,063
---------- ---------- ---------- ----------
NET EARNINGS........................................ $ 9,762 $ 6,167 $ 16,182 $ 10,850
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
EARNINGS PER SHARE.................................. $ .45 $ .42 $ .86 $ .74
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Weighted average shares outstanding................. 21,633 14,798 18,813 14,686
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
See accompanying notes to financial statements.
<PAGE>
QUALITY FOOD CENTERS, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
<TABLE>
<CAPTION>
JUNE 14, DECEMBER 28,
1997 1996
------------ -----------
<S> <C> <C>
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash and cash equivalents....................... $ 78,280 $ 14,571
Accounts receivable............................. 23,148 10,754
Notes receivable................................ 7,062 --
Inventories..................................... 117,146 36,954
Prepaid expenses................................ 19,387 6,208
---------- ----------
TOTAL CURRENT ASSETS............................ 245,023 68,487
PROPERTIES
Land............................................ 51,924 15,025
Buildings, fixtures and equipment............... 313,194 155,038
Leasehold improvements.......................... 74,626 41,511
Property under capital leases................... 23,721 --
Construction in progress........................ -- 9,910
---------- ----------
463,465 221,484
Accumulated depreciation and amortization....... (73,884) (60,821)
---------- ----------
389,581 160,663
LEASEHOLD INTEREST, net of accumulated
amortization of $12,768 and $11,257............ 105,424 27,585
Real estate held for investment................. 5,876 6,048
GOODWILL, net of accumulated amortization
of $3,879 and $2,084........................... 226,421 33,691
OTHER ASSETS.................................... 34,277 7,543
---------- ----------
$1,006,602 $304,017
---------- ----------
---------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable................................ $ 90,224 $ 35,548
Accrued payroll and related benefits............ 38,436 15,884
Accrued business and sales taxes................ 8,010 5,413
Other accrued expenses.......................... 37,463 7,240
Federal income taxes payable.................... 3,410 945
Notes payable................................... 391 --
Current portion of capital lease obligations.... 617 --
---------- ----------
TOTAL CURRENT LIABILITIES....................... 178,551 65,030
DEFERRED INCOME TAXES........................... 56,454 12,142
OTHER LIABILITIES............................... 18,619 5,047
LONG-TERM DEBT.................................. 400,244 145,000
CAPITAL LEASE OBLIGATIONS...................... 29,130 --
SHAREHOLDERS' EQUITY
Common stock, at stated value--authorized
60,000,000 shares, issued and outstanding
20,926,000 shares and 14,646,000 shares....... 265,569 34,945
Retained earnings.............................. 58,035 41,853
---------- ----------
TOTAL SHAREHOLDERS' EQUITY..................... 323,604 76,798
---------- ----------
$1,006,602 $ 304,017
---------- ----------
---------- ----------
</TABLE>
See accompanying notes to financial statements.
<PAGE>
QUALITY FOOD CENTERS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
TWENTY-FOUR WEEKS ENDED JUNE 14, 1997
(unaudited)
(in thousands)
<TABLE>
<CAPTION>
COMMON STOCK
--------------------- RETAINED
SHARES AMOUNT EARNINGS TOTAL
--------- ---------- --------- ----------
<S> <C> <C> <C> <C>
BALANCE AT
DECEMBER 28, 1996.................. 14,646 $ 34,945 $ 41,853 $ 76,798
NET EARNINGS....................... -- -- 16,182 16,182
COMMON STOCK ISSUED................ 6,280 230,624 -- 230,624
BALANCE AT
JUNE 14, 1997...................... 20,926 $ 265,569 $ 58,035 $ 323,604
--------- ---------- --------- ----------
--------- ---------- --------- ----------
</TABLE>
See accompanying notes to financial statements.
<PAGE>
QUALITY FOOD CENTERS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)
<TABLE>
<CAPTION>
TWENTY-FOUR WEEKS
ENDED
---------------------
JUNE 14, JUNE 15,
1997 1996
---------- ---------
<S> <C> <C>
OPERATING ACTIVITIES
Net earnings.................................................. $ 16,182 $ 10,850
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization of properties................... 12,929 7,437
Amortization of leasehold interest, goodwill and other........ 3,720 1,691
Amortization of debt issuance costs........................... 233 85
Deferred income taxes......................................... (114) 838
CHANGES IN OPERATING ASSETS AND LIABILITIES
Accounts receivable........................................... 71 144
Inventories................................................... 834 1,863
Prepaid expenses.............................................. 867 (1,087)
Accounts payable.............................................. 1,468 2,404
Accrued payroll and related benefits.......................... (1,699) (217)
Accrued business and sales taxes.............................. (1,180) 10
Other accrued expenses........................................ 9,482 250
Federal income taxes payable.................................. (357) 899
Other liabilities............................................. (917) --
---------- ---------
Net Cash Provided by Operating Activities..................... 41,519 25,167
---------- ---------
INVESTING ACTIVITIES
Capital expenditures, net..................................... (18,707) (17,040)
Proceeds from sale of fixed assests........................... 8,050 --
Acquisition of KUI............................................ (34,344) --
Acquisition of Hughes......................................... (346,023) --
Other......................................................... (1,588) (1,004)
---------- ---------
Net Cash Used by Investing Activities......................... (392,612) (18,044)
---------- ---------
FINANCING ACTIVITIES
Proceeds from issuance of common stock........................ 2,466 2,171
Net proceeds from March 19, 1997 financings -
Issuance of common stock...................................... 192,199 --
Issuance of senior subordinated notes......................... 146,250 --
Proceeds under credity facility............................... 248,001 --
Payment of outstanding credity facility....................... (197,000) --
Proceeds from (repayments of) long-term debt.................. 22,886 (11,500)
---------- ---------
Net Cash Provided (Used) by Financing Activities.............. 414,802 (9,329)
---------- ---------
NET INCREASE (DECREASE ) IN CASH AND CASH EQUIVALENTS......... 63,709 (2,206)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD.............. 14,571 10,933
---------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................... $ 78,280 $ 8,727
---------- ---------
---------- ---------
</TABLE>
See accompanying notes to financial statements.
<PAGE>
QUALITY FOOD CENTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
TWENTY-FOUR WEEKS ENDED JUNE 14, 1997 AND JUNE 15, 1996
(UNAUDITED)
NOTE A--NATURE OF OPERATIONS
Quality Food Centers, Inc. ("QFC") is a multi-regional operator of premium
supermarkets, operating 147 stores and employing more than 10,000 people. The
Company has been in operation since 1954 and currently operates 90 stores in the
Puget Sound region of Washington state primarily under the names QFC and Stock
Market and 57 stores in Southern California under the Hughes Family Market name.
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Financial Statement Preparation--The consolidated financial statements as of
and for the twelve and twenty-four weeks ended June 14, 1997 and June 15, 1996
are unaudited, but in the opinion of management include all adjustments
(consisting of normal recurring adjustments) necessary to present fairly the
consolidated financial position and results of operations and cash flows for the
periods presented. All significant intercompany transactions and account
balances have been eliminated in consolidation.
These statements have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC). Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been omitted
pursuant to such rules and regulations. These financial statements should be
read in conjunction with the annual audited financial statements and the
accompanying notes included in the Company's Annual Report on Form 10-K/A for
the year ended December 28, 1996.
Complying with generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting periods. Actual results could differ from the estimates.
Certain prior years' balances have been reclassified to conform to
classifications used in the current year.
Fiscal Periods--The Company's fiscal year ends on the last Saturday in
December (except for Hughes Markets, Inc.'s which ends on the last Sunday in
December), and its reporting quarters consist of three 12-week quarters and a
16-week fourth quarter.
Earnings Per Share--Earnings per share is based upon the weighted average
number of common shares and common share equivalents outstanding during the
period.
NOTE C--SUPPLEMENTAL CASH FLOW INFORMATION
On March 19, 1997, the Company completed (i) the sale of 5,175,000 shares of
the Company's common stock to the public for net proceeds of $192.2 million,
(ii) the private placement of $150.0 million of 8.7% senior subordinated notes
for net proceeds of $146.3 million, and (iii) entered into an agreement to amend
and restate its existing credit facility resulting in net proceeds of $248.0
million. The Company utilized $359.8 million of the proceeds to finance the
acquisition of Hughes Market, Inc. ("Hughes") and $197.0 million to refinance
the Company's bank indebtedness outstanding at the time of the financings
[including $59.1 million incurred in connection with the acquisition of Keith
Uddenberg, Inc. ("KUI")], leaving approximately $29.7 million of cash for
general corporate purposes.
<TABLE>
<CAPTION>
TWENTY-FOUR WEEKS
ENDED
------------------------
JUNE 14, JUNE 15,
(IN THOUSANDS) 1997 1996
- ------------------ ---------- ----------
<S> <C> <C>
Cash payments made:
Income taxes................................. $ 11,250 $ 4,325
Interest (net of $347 and $567 of interest
capitalized)................................ 6,144 4,278
Non-Cash Transactions:
Capital lease obligations incurred........... 2,530 --
--------- ---------
</TABLE>
During the twenty-four weeks ended June 14, 1997, the Company entered
into a capital lease in conjunction with the sale and leaseback of one of its
stores. No gain or loss was recorded as a result of this transaction.
6
<PAGE>
NOTE D--KEITH UDDENBERG, INC. ACQUISITION
On February 14, 1997, the principal operations of KUI, including assets
and liabilities related to 25 grocery stores in the western and southern
Puget Sound region of Washington, were merged into a subsidiary of the
Company, hereinafter defined as KU Acquisition Corporation ("KUA"). The
merger, which has been accounted for under the purchase method of accounting,
was effected through the acquisition of 100% of the outstanding voting
securities of KUI for consideration consisting of $35.3 million cash, 904,646
shares of the Company's common stock, (which as of February 14, 1997 had a
value of $36.0 million) and the assumption by the Company of approximately
$23.8 million of indebtedness of KUI.
For financial reporting purposes, the consideration paid for the
operations of KUI has been allocated to the fair value of assets acquired and
liabilities assumed. Goodwill of $46.7 million has been recorded as a result
of the merger and is being amortized over 40 years. Because the transaction
was a statutory merger, the Company has a carryover tax basis and
amortization of the excess of the book value over the tax basis of the assets
included in the merger is not deductible for federal income tax purposes.
Following is a summary of the assets and liabilities recorded as a result
of the KUI merger (in thousands):
<TABLE>
<S> <C>
Cash..................................................... $ 1,262
Inventories.............................................. 15,985
Other current assets..................................... 4,749
-----------
Total current assets................................... 21,996
Property, plant and equipment............................ 25,047
Leasehold interest....................................... 20,000
Goodwill................................................. 46,685
Other assets............................................. 12,330
Current liabilities...................................... (16,507)
Deferred income taxes.................................... (10,635)
Other liabilities........................................ (3,839)
Long-term debt........................................... (23,768)
--------------
$ 71,309
--------------
--------------
</TABLE>
Long-term debt of $23.8 million assumed in connection with the merger was
subsequently repaid.
NOTE E--HUGHES MARKETS, INC. ACQUISITION
On March 19, 1997, the Company acquired the principal operations of Hughes,
including the assets and liabilities related to 57 grocery stores located in
Southern California and a 50% interest in Santee Dairies, Inc., one of the
largest dairy plants in California. The acquisition, which has been accounted
for under the purchase method of accounting, was effected through the
acquisition of 100% of the outstanding voting securities of Hughes, for cash
consideration of approximately $359.8 million, and the assumption by the Company
of approximately $33.2 million of indebtedness (including $6.1 million of
current indebtedness) of Hughes, consisting primarily of capitalized store
leases.
For financial reporting purposes, the consideration paid for Hughes has been
allocated to the fair value of assets acquired and liabilities assumed. Goodwill
of $147.7 million has been recorded as a result of the acquisition and is being
amortized over 40 years. Because the transaction was a statutory merger, the
Company has a carryover tax basis and amortization of the excess of the book
value over the tax basis of the assets included in the merger is not deductible
for federal income tax purposes.
7
<PAGE>
NOTE E--continued
Following is a summary of the assets and liabilities recorded as a result of
the Hughes merger (in thousands):
<TABLE>
<S> <C>
Cash........................................ $ 13,767
Inventories................................. 65,042
Other current assets........................ 20,782
---------
Total current assets...................... 99,591
Property, plant and equipment............... 182,999
Property under capital leases............... 21,191
Leasehold interest.......................... 59,353
Goodwill.................................... 147,729
Other assets................................ 14,178
Current liabilities......................... (94,935)
Deferred income taxes....................... (33,584)
Other liabilities........................... (9,680)
Long-term debt.............................. (278)
Capital lease obligation.................... (26,774)
---------
$ 359,790
---------
---------
</TABLE>
NOTE F--PRO FORMA FINANCIAL INFORMATION
The following pro forma financial information assumes that the acquisitions
of KUI and Hughes and the related financings each occurred as of the beginning
of each period presented (in thousands, except per share data):
<TABLE>
<CAPTION>
24 WEEKS 24 WEEKS
ENDED ENDED
JUNE 14, 1997 JUNE 15, 1996
------------------- ------------------
<S> <C> <C>
Sales................................ $ 964,610 $ 970,716
Net earnings 16,638 13,924
Earnings per share................... $ 0.77 $ 0.67
</TABLE>
NOTE G--ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standard (SFAS) No. 128, "Earnings per
Share," was recently issued and is effective for the Company's fiscal year
ending December 27, 1997. This Statement requires a change in the presentation
of earnings per share. Early adoption of this statement is not permitted.
Management believes that the impact of the adoption of this Statement on the
financial statements, taken as a whole, will not be material.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," was also recently issued and is effective for the Company's
year ending December 26, 1998. The Company is currently evaluating the
effects of this Standard; however, management believes the impact of its
adoption will not be material to the financial statements, taken as a whole.
8
<PAGE>
NOTE H--SUMMARIZED FINANCIAL INFORMATION--SUBSIDIARY GUARANTORS
The Company issued $150.0 million aggregate principal amount of 8.70% Senior
Subordinated Notes, due 2007 (the "Notes"), in a private offering (exempt from
the registration requirements of the Securities Act) pursuant to Rule 144A to
institutional investors. The Notes are fully and unconditionally guaranteed,
jointly and severally on a senior subordinated basis, by Hughes, KUA and Quality
Food Holdings, Inc. ("Holdings"), all of which are existing subsidiaries of the
Company. Summarized financial information for subsidiary guarantors of the Notes
is set forth below. Separate financial statements for the subsidiary guarantors
of the Notes are not presented because the Company has determined that such
financial statements would not be material to investors. The subsidiary
guarantors comprise all of the direct and indirect subsidiaries of the Company,
other than the non-guarantor subsidiaries which individually, and in the
aggregate, are inconsequential.
On May 20, 1997, the Company filed a Registration Statement on Form S-4
(File No. 333-27497) for the purpose of offering to exchange up to
$150,000,000 aggregate principal amount of 8.70% Series B Senior Subordinated
Notes due 2007 (the "Exchange Notes") for a like aggregate principal amount
of the Notes (the "Exchange Offer Registration Statement"). The terms of the
Exchange Notes are identical in all material respects (including principal
amount, interest rate and maturity) to the terms of the Notes for which they
may be exchanged, except that the Exchange Notes will be freely transferable
by the holders thereof. The Exchange Offer Registration Statement was
declared effective on July 23, 1997.
The following table presents combined summarized financial information for
subsidiary guarantors of the Notes. The statement of earnings data represent the
combined results of operations for the period from February 15, 1997 through
June 14, 1997 for KUA, from March 20, 1997 through June 15, 1997 for Hughes, and
from February 18, 1997 (date of inception) through June 14, 1997 for Holdings.
June 14, 1997
-----------------
Balance Sheet Data (in thousands):
Current assets $ 118,139
Noncurrent assets 521,771
Current liabilities 97,816
Noncurrent liabilities 338,419
Shareholders' equity 203,675
For the period
ended June 14, 1997
-----------------------
Statement of Earnings Data (in thousands):
Sales $ 350,789
Operating income 12,433
Earnings before income taxes 10,127
Net earnings 5,176
9
<PAGE>
QUALITY FOOD CENTERS, INC.
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FORWARD LOOKING INFORMATION
Certain information contained herein contains forward-looking statements
that involve a number of risks and uncertainties. A number of factors could
cause results to differ materially from those anticipated by such
forward-looking statements. These factors include, but are not limited to, the
competitive environment in the supermarket industry in general and in the
Company's specific market areas, changes in prevailing interest rates and the
availability of financing, inflation, changes in costs of goods and services,
economic conditions in general and in the Company's specific market areas, labor
disturbances, demands placed on management by the substantial increase in the
size of the Company because of the acquisitions described below, and changes in
the Company's acquisition plans. In addition, such forward-looking statements
are necessarily dependent upon assumptions, estimates and data that may be
incorrect or imprecise. Accordingly, any forward-looking statements included
herein do not purport to be predictions of future events or circumstances and
may not be realized. Forward-looking statements contained herein include, but
are not limited to, statements relating to same store sales, inflation, regional
economies, investments in existing stores, sales of certain KUI (as defined
below) stores, the availability of financing for Santee (as defined below),
future acquisitions and anticipated capital expenditures.
TWELVE AND TWENTY-FOUR WEEKS ENDED JUNE 14, 1997 COMPARED TO THE TWELVE AND
TWENTY-FOUR WEEKS ENDED JUNE 15, 1996
During the twenty-four weeks ended June 14, 1997, the Company acquired 57
stores from Hughes Markets, Inc. ("Hughes") operating under the "Hughes
Market" name and 25 stores from Keith Uddenberg, Inc. ("KUI") operating under
the "Stock Market" and "Thriftway" names. (See Notes D and E to the Company's
consolidated financial statements for the twenty-four weeks ended June 14,
1997.) The acquisitions more than doubled the size of the Company, and
managing the Company and integrating the acquired businesses will present new
challenges to management. In order to facilitate this phase of the Company's
development, the Company has hired a new chief executive officer, a new
senior vice president of corporate development and a new senior vice
president of marketing and public affairs to pursue and integrate
acquisitions at a holding company level, thus allowing current senior
management to remain focused on existing operations. Because of the magnitude
of the acquisitions, the Company's operations are not comparable to QFC's or
Hughes' historical operations. The Company's capitalization has also changed,
reflecting the issuance of shares as well as a significant increase in
long-term debt and a related increase in interest expense. The results of
operations for the twelve weeks ended June 14, 1997, include the results of
operations of the acquired from Hughes and KUI stores for the entire
twelve-week period. The results of operations for the twenty-four weeks ended
June 14, 1997, include the results of operations of the KUI stores for 17
weeks and the Hughes stores for approximately 13 weeks. Additionally, results
of operations reflect the effects of the related financings which occurred on
March 19, 1997.
The table below sets forth items in the Company's statements of earnings as
a percentage of sales:
<TABLE>
<CAPTION>
12 WEEKS ENDED 24 WEEKS ENDED
------------------------ ------------------------
<S> <C> <C> <C> <C>
JUNE 14, JUNE 15, JUNE 14, JUNE 15,
1997 1996 1997 1996
----------- ----------- ----------- -----------
Sales.................................................................... 100.0% 100.0% 100.0% 100.0%
Cost of sales & related occupancy expenses............................... 76.0 75.0 75.7 75.2
Marketing, general & administrative expenses............................. 19.2 18.7 19.3 18.9
----- ----- ----- -----
Operating income......................................................... 4.8 6.3 5.0 5.9
Interest income ......................................................... .1 .1 .1 .1
Interest expense......................................................... (1.6) (1.2) (1.4) (1.3)
----- ----- ----- -----
Earnings before income taxes............................................. 3.3 5.2 3.7 4.7
Taxes on income.......................................................... 1.4 1.9 1.5 1.7
----- ----- ----- -----
Net earnings............................................................. 1.9% 3.3% 2.2% 3.0%
----- ----- ----- -----
----- ----- ----- -----
</TABLE>
10
<PAGE>
QUALITY FOOD CENTERS, INC.
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(continued)
SALES
Sales for the 12 weeks ended June 14, 1997 increased approximately $316.7
million, or 171.8%, compared with the same period in 1996. The increase in
total sales reflects the inclusion of the 25 KUI stores (one of which was
sold on May 3, 1997) and the 57 Hughes stores for the entire quarter, sales
from the 45,000 square-foot Harvard Market store which opened April 30, 1997,
sales from two Food Giant stores acquired in October 1996, and an increase in
same store sales (which exclude sales in stores opened or acquired during the
previous 12 months) of approximately 2% for the quarter. The increase in same
store sales is due to improved merchandising and strong sales in remodeled
and replacement stores, despite a decrease of nearly 1% in retail food
prices. Sales for the 24 weeks ended June 14, 1997, increased approximately
$373.3 million, or 103.4%, compared with the same period in 1996. The
increase for the 24 weeks reflects the inclusion of the KUI stores for 17
weeks and the Hughes stores for approximately 13 weeks.
Sales increases for the 12 and 24 weeks ended June 14, 1997, were offset
in part by lower sales in certain existing stores due to the opening and
remodeling of competitors' stores located near QFC stores. In addition, sales
growth has been impacted by new and acquired stores, which have lower sales
volumes, becoming a more significant part of the Company's sales, the
maturing of older stores to a level where substantial sales growth is more
difficult, and the Company's strategy of opening and acquiring stores in
certain locations that enhance the Company's competitive position and protect
its market share but reduce sales in nearby existing stores. Additionally,
the supermarket industry continues to be highly competitive.
Management believes that same store sales should remain positive in the
third quarter of 1997, and will be flat in the 4th quarter of 1997 due to the
impact of external factors which positively affected sales in 1996. Further,
no inflation or slight deflation is anticipated for the remainder of 1997 and
the regional economies in which the Company operates are projected to remain
healthy.
OPERATING INCOME
The Company's cost of sales and related occupancy expenses increased to
76.0% of sales for the 12 weeks ended June 14, 1997, from 75.0% for the same
period of 1996 due to lower margins in the stores acquired in the first
quarter of 1997 offset, in part, by improved buying and merchandising, a
greater mix of sales in higher margin service departments in the QFC stores
and lower occupancy expenses as a percentage of sales. The 0.5% increase in
cost of sales and related occupancy expenses for the 24 weeks ended June 14,
1997, compared to 75.2% of sales for the 24 weeks ended June 15, 1996 was due
to the same factors as described above.
Marketing, general and administrative expenses increased to 19.2% and
19.3% of sales for the 12 and 24 weeks ended June 14, 1997, respectively,
from 18.7% and 18.9% of sales, respectively, for the same periods of 1996.
The increases were attributable to contractual rate increases from union
contracts effective in May 1997 and August 1996 and a 10% increase in the
union benefit contributions rate effective in July 1996 as well as additional
expenses associated with the initial integration and a higher operating
expense ratio of the acquired stores, as well as an increase in acquisition
related amortization of $2.0 million and $2.3 million for the 12 and 24 weeks
ended June 14, 1997, respectively.
As a result of the above factors, operating margins declined to 4.8% of
sales for the 12 weeks ended June 14, 1997, compared to 6.3% of sales for the
comparable period in 1996, and to 5.0% for the 24 weeks ended June 14, 1997,
compared to 5.9% for the comparable period in 1996.
INTEREST
Interest income increased to $704,000 and $893,000 for the 12 and 24
weeks ended June 14, 1997, respectively, compared to $112,000 and $184,000
for the same periods of 1996, reflecting the increase in the Company's cash
balances and higher interest rates.
Interest expense increased $5.8 million and $6.0 million for the 12 and
24 weeks ended June 14, 1997, respectively, as compared to the same periods
in 1996, which reflects interest on the additional debt incurred in
connection with the acquisitions, offset by lower debt balances than in the
comparable year prior to such borrowings. Interest expense is net of
approximately $135,000 and $347,000 of interest capitalized in connection
with store construction and remodeling costs incurred during the 12 and 24
weeks ended June 14, 1997, respectively, and $390,000 and $567,000 of
interest capitalized during the 12 and 24 weeks ended June 15, 1996,
respectively.
11
<PAGE>
QUALITY FOOD CENTERS, INC.
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(continued)
INCOME TAXES
The Company's effective federal income tax rate increased to 41.6% and
40.1% for the 12 weeks and 24 weeks ended June 14, 1997, respectively,
compared to 35.8% for both the 12 weeks and 24 weeks ended June 15, 1996, due
to an increase in non-deductible goodwill resulting from the KUI and Hughes
acquisitions and the addition of state of California income taxes as a result
of the Hughes acquisition. The difference between the Company's effective
income tax rate and the federal and state statutory rates is primarily due to
non-deductible amortization of goodwill that was acquired through various
acquisitions by the Company, including the KUI and Hughes acquisitions.
NET EARNINGS
The 106.0% increase in operating income for the 12 weeks ended June 14,
1997, offset by the $5.2 million increase in the net interest expense and the
increase in the effective tax rate resulted in an increase in net earnings to
$9.8 million compared with $6.2 million for the 12 weeks ended June 15, 1996.
Earnings per share were 45 cents on 21,633,000 weighted average shares
outstanding, compared with 42 cents on 14,798,000 weighted average shares
outstanding in 1996.
The 71.6% increase in operating income for the 24 weeks ended June 14,
1997, offset by the $5.3 million increase in net interest expense and the
increase in the effective tax rate resulted in a 49.1% increase in net
earnings compared with the same period of 1996. Earnings per share were 86
cents on 18,813,000 weighted average shares outstanding compared to 74 cents
on 14,686,000 weighted average shares outstanding in 1996.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal source of liquidity has been cash generated from
operations and its credit facility. On March 19, 1997, the Company completed
(i) the sale of 5,175,000 shares of the Company's common stock to the public
for net proceeds of $192.2 million, (ii) the private placement of $150.0
million of 8.7% senior subordinated notes for net proceeds of $146.3 million,
and (iii) entered into an agreement to amend and restate its existing credit
facility resulting in net proceeds of $248.0 million. The Company utilized
$359.8 million of the proceeds to finance the acquisition of Hughes and
$197.0 million to refinance the Company's bank indebtedness outstanding at
the time of the financings (including $59.1 million incurred in connection
with the acquisition of KUI), leaving approximately $29.7 million of cash for
general corporate purposes. This amount, together with cash provided by
operations of $41.5 million and proceeds received in conjuction with the sale
and leaseback of a Hughes store, more than offset capital expenditures and
other investing activities during the 24 weeks ended June 14, 1997, and
resulted in an increase in cash and cash equivalents of $63.7 million during
the period to $78.3 million. The ratio of current assets to current
liabilities at June 14, 1997, improved to 1.37 to 1, compared with 1.05 to 1
at December 28, 1996.
12
<PAGE>
QUALITY FOOD CENTERS, INC.
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(continued)
The Company's expansion and remodeling and new store activities for the
period from 1987 through June 14, 1997 are summarized below (dollars in
thousands):
<TABLE>
<CAPTION>
NEW OR SQUARE
MAJOR ACQUIRED FEET CAPITAL
REMODELS STORES ADDED EXPENDITURES
----------------- ----------------- --------- -----------------
<S> <C> <C> <C> <C>
1987 2 -- 8,000 $ 5,700
1988 5 -- 16,000 7,600
1989 2 2 85,000 9,900
1990 3 3 107,000 16,600
1991 3 3 127,000 25,900
1992 6 3 137,000 26,800
1993 3 5 173,000 43,000
1994 4 7 239,000 28,200
1995 7 17 609,000 89,100
1996 13 2 111,000 33,000
1997 13 83 3,088,000 449,800
-- --- --------- ---------
TOTAL 61 125 4,700,000 $ 735,600
-- --- --------- ---------
-- --- --------- ---------
</TABLE>
(1) Includes replacement stores.
(2) Includes $71.3 million for the acquisition of KUI, $359.8 million for the
acquisition of Hughes, expenditures for Hughes' expansion in 1997 and
expenditures for the purchase of real estate held for investment.
1997 was the Company's most active year to date in terms of growth, with
the acquisition of Hughes and KUI during the first quarter of 1997, the
opening of a 45,000 square foot Harvard Market store located in Seattle,
Washington in April of 1997 and the acquisition of a store in Port Hadlock,
Washington in June of 1997 from a local independent retailer. QFC also
continues to invest in its existing stores to keep them up-to-date. In
addition to the remodeling of one of the two Food Giant stores the Company
acquired in 1996, the Company's fiscal 1997 remodel plans currently include
13 of its QFC stores and 12 of the stores it acquired in the KUI acquisition.
The Company has secured a number of other sites that are still in the
entitlement process or subject to other contingencies and is actively
pursuing other new store locations and acquisition opportunities. The Company
has sold one of the stores it acquired from KUI and is actively marketing
four other KUI stores. The Company has also entered into lease agreements for
two QFC stores to be built in the Portland, Oregon area, which are expected
to be opened in early 1998 and has entered into agreements for two sites in
the Olympia, Washington area. The Company will own its store pads and plans
to open the Olympia QFC stores in 1998 as well. The Company's plans for the
remainder of 1997 in southern California currently include one new store, two
replacement stores and two major store remodels.
The Company owns the real estate at 12 of its 147 store facilities
currently in operation. The Company owns the strip shopping center where one
of these stores is located; however, the real estate operations of this
center is currently insignificant to the Company's results of operations.
The shopping center is for sale; however, the Company plans to retain
ownership of its store building and pad. The remaining stores are leased
under long-term operating leases. The Company, through Hughes, also owns a
600,000 square foot distribution facility in Irwindale, California.
As part of the Hughes acquisition, the Company acquired a 50% interest in
Santee Dairies, Inc. ("Santee"), one of the largest dairy plants in
California. Santee has begun construction of a new dairy plant in order to
provide a consistent source of milk, accommodate expected expansion and
contain operating costs. The estimated cost of construction is approximately
$100.0 million (including production equipment and capitalized interest and
other costs). The new dairy is scheduled to be completed in December 1997 and
be operational by March 1998. Approximately 57% of the aggregate budgeted
capital expenditures have been made. Negotiations are currently under way
with certain parties to provide Santee with approximately $80.0 million of
senior secured notes to finance construction costs. The prospective lenders
have orally agreed in principle to certain primary terms of such long-term
financing, including the applicable interest rate and have been paid a
non-refundable fee in connection therewith. There is no assurance, however,
that Santee will be able to obtain this long-term financing on acceptable
terms, or at all. In that regard, the Company, and the other 50% partner, may
be required to provide certain credit support for any long-term financing
which Santee may arrange or otherwise enter into agreements intended to
assure repayment of such
13
<PAGE>
QUALITY FOOD CENTERS, INC.
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(continued)
indebtedness. Santee is currently in default under certain of the financial
covenants relating to its existing credit facilities, and is negotiating with
its lender to extend its existing credit facilities and to obtain the
appropriate waivers. Notwithstanding such default, its lender has allowed
Santee to continue to borrow under its existing credit facility without a
formal waiver.
Excluding the KUI and Hughes acquisitions, capital expenditures, which
include the purchase of land, fixtures, equipment and leasehold improvements,
as well as the purchase of leasehold interests, other property rights,
goodwill and covenants not to compete, are projected to be approximately
$80.0 million in 1997 in order to remodel existing stores and to acquire and
open new stores in the Pacific Northwest and Southern California. However,
the Company will continue to seek attractive acquisitions of other regional
supermarkets and supermarket chains, as well as additional stores and store
sites and actual capital expenditures may increase significantly to the
extent that these opportunities arise and the Company is able to obtain
financing for these acquisitions. Accordingly, the Company is unable to
predict with certainty its capital expenditure budget for 1997 or any future
period.
The Company has discontinued the payment of cash dividends on its common
stock pursuant to covenants contained in its debt agreements discussed below,
and presently intends to retain available funds to finance the growth and
operations of its businesses.
On March 19, 1997, in connection with the Hughes merger, the Company
entered into a new credit facility which replaced the credit facility it
entered into in connection with its 1995 recapitalization. The new credit
facility consists of (i) a $250 million term loan facility (the "Term Loan
Facility"), (ii) a $125 million revolving credit facility (the "Revolving
Credit Facility") and (iii) a $225 million reducing revolving credit facility
(the "Acquisition Facility"). Principal repayments under the Term Loan
Facility are due in quarterly installments from June 30, 1998 through the
final maturity of the new credit facility in March of 2004 and the Company
will be required to repay borrowings under the Term Loan Facility with the
proceeds from certain asset sales and, under certain circumstances, with cash
flow in excess of certain specified amounts. The Revolving Credit Facility is
available for working capital and other general corporate purposes, including
permitted acquisitions, and any outstanding amounts thereunder will become
due on March 31, 2004. The Acquisition Facility is to be used to consummate
permitted acquisitions and will become due on March 31, 2004. In addition,
the maximum amount of available borrowings under the Acquisition Facility
will decline by $30 million each year commencing March 31, 2000, and the
borrower thereunder will be required to repay borrowings thereunder to the
extent that they exceed the reduced amount of the Acquisition Facility.
Additionally, the Revolving Credit Facility and the Acquisition Facility may
be used to make investments in Santee in an amount not to exceed $80.0
million to finance construction of Santee's new dairy.
On the date the new credit facility became effective, the Company
borrowed $250.0 million under the Term Loan Facility. At the Company's
option, the interest rate per annum applicable to the new credit facility
will either be (1) the greater of one of the bank agents' reference rate or
0.5% above the federal funds rate in each case, plus a margin (0% initially)
or (2) IBOR plus a margin (0.875% initially), in each case with margin
adjustments dependent on the borrower's senior funded debt to EBITDA ratio
from time to time.
The new credit facility contains a number of significant covenants that
among other things, restrict the ability of the Company and its subsidiaries
to incur additional indebtedness and incur liens on their assets, in each
case subject to specified exceptions, impose specified financial tests as a
precondition to the Company and its subsidiaries' acquisition of other
businesses, and limit the Company and its subsidiaries from making certain
restricted payments (including dividends and repurchases of stock), subject
in certain circumstances to specified financial tests. The obligations of the
Company under the new credit facility have been guaranteed by certain
existing subsidiaries. In addition, the Company has pledged the outstanding
shares of certain subsidiaries as security under the facility. In addition,
the Company and its subsidiaries will be required to comply with specified
financial ratios and tests, including an interest and rental expense coverage
ratio, a total funded debt to EBITDA ratio, a senior funded debt to EBITDA
ratio and a minimum net worth test. The covenants and ratios under the new
credit facility and the Notes described below were negotiated to provide
appropriate flexibility to facilitate the Company's growth strategies.
As discussed above, on March 19, 1997, the Company issued $150 million
aggregate principal amount of Senior Subordinated Notes in a private
offering. The Notes will mature on March 15, 2007. The Notes bear interest at
8.70% per annum with interest payable in cash semi-annually on March 15 and
September 15 of each year, commencing September 15, 1997. The Notes are
redeemable, in whole or in part, at the option of the Company beginning March
15, 2002, at redemption prices declining over time from 104.35% of the
principal amount in the year 2002 to 100% of the principal amount in the year
2005 and thereafter, in each case plus accrued and unpaid interest to the
redemption date. In addition, at any time prior to March 15, 2000, the
Company may redeem up to 20% of the aggregate principal amount of the Notes
originally issued at a redemption price of 108% of the principal amount
thereof, plus accrued and unpaid interest to the date of
14
<PAGE>
QUALITY FOOD CENTERS, INC.
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(continued)
redemption, with the net cash proceeds of one or more public offerings of
common stock of the Company, provided that at least 80% of the aggregate
principal amount of the Notes originally issued remains outstanding
immediately after the occurrence of such redemption. The obligations of the
Company pursuant to the Notes are fully and unconditionally guaranteed on a
joint and several basis by certain of QFC's existing subsidiaries (the
"Guarantors"). The Notes are general unsecured obligations of the Company and
the Guarantors, respectively, subordinated in right of payment to all
existing and future senior debt of the Company and the Guarantors, as
applicable, including borrowings and guarantees under the new credit
facility. Upon a change of control, the Company will be required to offer to
repurchase all outstanding Notes at 101% of the principal amount thereof,
plus accrued and unpaid interest to the date of repurchase. The Company will
also be obligated in certain circumstances to offer to repurchase Notes at a
purchase price of 100% of the principal amount thereof, plus accrued
interest, with the net cash proceeds of certain sales or other dispositions
of assets. The Indenture relating to the Notes contains certain covenants
that limit, subject to certain significant exceptions, the ability of the
Company and its subsidiaries to, among other things, incur additional
indebtedness and issue disqualified stock; pay dividends or make certain
other distributions; cause or permit to exist any consensual restriction on
the ability of certain parties to pay dividends or make certain other
distributions; layer indebtedness; create certain liens securing indebtedness
other than senior debt; enter into certain transactions with affiliates;
enter into certain mergers and consolidations or engage in new lines of
business.
On May 20, 1997, the Company filed a Registration Statement for the
purpose of offering to exchange up to $150,000,000 aggregate principal amount
of 8.70% Series B Senior Subordinated Notes due 2007 (the "Exchange Notes")
for a like aggregate principal amount of the Notes (the "Exchange Offer
Registration Statement"). The terms of the Exchange Notes are identical in
all material respects (including principal amount, interest rate and
maturity) to the terms of the Notes for which they may be exchanged, except
that the Exchange Notes will be freely transferable by the holders thereof.
The Exchange Offer Registration Statement was declared effective on July 23,
1997.
The Company is currently in compliance with all financial covenants
contained in both the new credit facility and the Senior Subordinated Notes.
The Company anticipates that cash on hand, cash flow from operations and
borrowings under the new credit facility will be sufficient to provide
financing for the $61.3 million of capital expenditures which is currently
budgeted through the remainder of fiscal 1997. However, to the extent that
the Company pursues additional acquisitions or seeks to make additional
expenditures or to the extent that Santee is unable to obtain the required
financing for its new dairy, the Company may be required to seek additional
sources of financing, which may include additional borrowings or sales of its
common stock and there can be no assurance that the Company will be able to
obtain such additional financing on acceptable terms or at all. In December
1996, the Company filed a universal shelf registration statement with the
Securities and Exchange Commission registering for sale to the public, an
aggregate of $500.0 million of securities, under which, after the secondary
common stock offering described above, $298.2 million of common stock,
preferred stock and certain debt securities may be sold. The Company has from
time to time issued shares of common stock for all or a portion of the
purchase price of acquisitions (as it did for a portion of the Olson's Merger
in 1995 and as it did in the KUI acquisition) and may do so again in the
future.
ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standard (SFAS) No. 128, "Earnings per
Share." was recently issued and is effective for the Company's fiscal year
ending December 27, 1997. This Statement requires a change in the
presentation of earnings per share. Early adoption of this statement is not
permitted. Management believes that the impact of the adoption of this
Statement on the financial statements, taken as a whole, will not be material.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," was also recently issued and is effective for the Company's
year ending December 26, 1998. The Company is currently evaluating the
effects of this Standard; however, management believes the impact of its
adoption will not be material to the financial statements, taken as a whole.
INFLATION
The Company's sales for the 12 and 24 weeks ended June 14, 1997, and June
15, 1996, reflect a decrease of nearly 1% in retail food prices.
15
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
No material legal proceedings were commenced during the quarter.
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. The following documents are filed as part of this report:
Exhibit 11.0--Statement regarding computation of earnings per share.
Exhibit 27.0--Financial Data Schedule.
B. The Company filed a current report on Form 8-K on March 27, 1997.
16
<PAGE>
SIGNATURE
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.
QUALITY FOOD CENTERS, INC.
(REGISTRANT)
DATE: JULY 29, 1997 /S/ MARC W. EVANGER
--------------------
MARC W. EVANGER
VICE PRESIDENT
CHIEF FINANCIAL OFFICER
17
<PAGE>
EXHIBIT INDEX
EXHIBIT NUMBER EXHIBIT
- ----------------- -------
11.0 Statement regarding computation
of per share earnings
27.0 Financial Data Schedule
18
<PAGE>
Exhibit 11.WP
QUALITY FOOD CENTERS, INC.
EXHIBIT 11.0
COMPUTATION OF PER SHARE EARNINGS
Calculations of per share earnings reported in this report on Form 10-Q are
based on the following:
12 Weeks Ended 24 Weeks Ended
June 14, June 15, June 14, June 15,
1997 1996 1997 1996
--------- -------- -------- --------
Weighted average
shares outstanding..... 20,908,000 14,543,000 18,101,000 14,489,000
Dilutive effect of
stock options.......... 725,000 255,000 712,000 197,000
---------- ---------- ---------- ----------
Weighted average
number of shares....... 21,633,000 14,798,000 18,813,000 14,686,000
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
19
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-27-1997
<PERIOD-START> DEC-29-1996
<PERIOD-END> JUN-14-1997
<CASH> 78,280
<SECURITIES> 0
<RECEIVABLES> 23,148
<ALLOWANCES> 0
<INVENTORY> 117,146
<CURRENT-ASSETS> 245,023
<PP&E> 463,465
<DEPRECIATION> (73,884)
<TOTAL-ASSETS> 1,006,602
<CURRENT-LIABILITIES> 178,551
<BONDS> 0
0
0
<COMMON> 265,569
<OTHER-SE> 58,035
<TOTAL-LIABILITY-AND-EQUITY> 1,006,602
<SALES> 734,282
<TOTAL-REVENUES> 734,282
<CGS> 555,587
<TOTAL-COSTS> 697,409
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (10,767)
<INCOME-PRETAX> 26,999
<INCOME-TAX> 10,817
<INCOME-CONTINUING> 16,182
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 16,182
<EPS-PRIMARY> .86
<EPS-DILUTED> .86
</TABLE>
