<PAGE>
Filed pursuant to Rule 424(B)(5)
Registration No. 333-18567
PROSPECTUS SUPPLEMENT
(TO PROSPECTUS DATED JANUARY 27, 1997)
4,500,000 SHARES
[LOGO]
QUALITY FOOD CENTERS, INC.
[LOGO]
COMMON STOCK
------------------------------
All of the 4,500,000 shares of Common Stock being offered hereby are being
sold by Quality Food Centers, Inc. ("QFC" or the "Company"). Of the 4,500,000
shares of Common Stock offered hereby, 900,000 shares are being offered outside
of the United States and Canada by the International Managers (the
"International Offering") and 3,600,000 shares are being offered in a concurrent
offering in the United States and Canada by the U.S. Underwriters (the "U.S.
Offering" and, together with the International Offering, the "Common Stock
Offering"). The price to public and underwriting discount per share are
identical for the International Offering and the U.S. Offering. See
"Underwriting."
The Common Stock offered hereby is being issued to provide part of the
financing necessary to pay the total cash consideration in connection with QFC's
proposed acquisition of Hughes Markets, Inc. ("Hughes") (the "Hughes
Acquisition") and to refinance QFC's bank indebtedness, including indebtedness
incurred by QFC in connection with its recent acquisition of Keith Uddenberg,
Inc. (the "KUI Acquisition," and, collectively with the Hughes Acquisition, the
"Acquisitions"). Concurrently with the Common Stock Offering, the Company will
enter into the New Credit Facility (as defined herein) and privately place
certain debt securities (the "Notes Offering") (the Common Stock Offering, the
New Credit Facility and the Notes Offering being herein referred to as the
"Financings"). The Common Stock Offering is contingent upon the effectiveness of
the New Credit Facility and the concurrent consummation of the Notes Offering
and the Hughes Acquisition. See "Use of Proceeds" and "The Acquisitions."
Following consummation of the Hughes Acquisition, the Company intends to
seek shareholder approval to change its corporate structure (the
"Reorganization"). Subject to obtaining such shareholder approval, upon
consummation of the Reorganization, the surviving corporation in the KUI
Acquisition ("KUI") will remain a subsidiary of QFC, and each of QFC and Hughes
will become a subsidiary of Quality Food Holdings, Inc., a Delaware corporation
("Holding Company"), which in turn will be a subsidiary of Quality Food, Inc., a
Delaware corporation ("Parent"), and the current shareholders of QFC (including
those who purchase Common Stock offered hereby) will thereupon become
shareholders of Parent. Parent and Holding Company are both currently
subsidiaries of QFC. See "The Proposed Reorganization."
QFC's Common Stock is listed on the New York Stock Exchange under the symbol
"XQ," On March 13, 1997, the last reported sale price of the Common Stock was
$39.25 per share.
SEE "RISK FACTORS" BEGINNING ON PAGE S-19 FOR A DISCUSSION OF CERTAIN
MATTERS THAT SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS.
--------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS SUPPLEMENT OR THE RELATED
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2)
<S> <C> <C> <C>
Per Share................................................ $39.00 $1.66 $37.34
Total (3)................................................ $175,500,000 $7,470,000 $168,030,000
</TABLE>
(1) The Company has agreed to indemnify the several Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933. See
"Underwriting."
(2) Before deducting expenses payable by the Company estimated at $836,000.
(3) The Company has granted the International Managers and the U.S. Underwriters
(the "Underwriters") options exercisable within 30 days after the date
hereof to purchase up to 135,000 and 540,000 additional shares of Common
Stock, respectively, in each case to cover over-allotments, if any. See
"Underwriting." If all such shares are purchased, the total Price to Public,
Underwriting Discount and Proceeds to Company will be $201,825,000,
$8,590,500 and $193,234,500, respectively.
--------------------------
The shares of Common Stock are being offered by the Underwriters, subject to
prior sale, when, as and if delivered to and accepted by the Underwriters, and
subject to the approval of certain legal matters by counsel for the Underwriters
and to certain other conditions. The Underwriters reserve the right to withdraw,
cancel or modify such offer and to reject any order in whole or in part. It is
expected that delivery of the shares of Common Stock will be made in New York,
New York on or about March 19, 1997.
------------------------------
<TABLE>
<S> <C>
MERRILL LYNCH INTERNATIONAL DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
SALOMON BROTHERS INTERNATIONAL LIMITED DAIN BOSWORTH
Incorporated
CREDIT LYONNAIS SECURITIES DRESDNER KLEINWORT BENSON
PARIBAS UBS LIMITED
</TABLE>
------------------------------
The date of this Prospectus Supplement is March 13, 1997.
<PAGE>
Certain persons participating in this offering may engage in transactions
that stabilize, maintain, or otherwise affect the price of the Common Stock.
Such transactions may include stabilizing the purchase of Common Stock to cover
syndicate short positions and the imposition of penalty bids. For a description
of these activities, see "Underwiting."
AVAILABLE INFORMATION
QFC is subject to the informational requirements of the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), and in accordance therewith files
reports, proxy and information statements and other information with the
Securities and Exchange Commission (the "SEC"). Such reports, proxy and
information statements and other information filed by QFC can be inspected and
copied at the public reference facilities of the SEC, Room 1024, Judiciary
Plaza, 450 Fifth Street, N.W., Washington, DC 20549, as well as at the following
SEC Regional Offices: Seven World Trade Center, New York, NY 10048; and
Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, IL
60661-2511. Copies can be obtained from the SEC by mail at prescribed rates.
Requests should be directed to the SEC's Public Reference Section, Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, DC 20549. The SEC maintains
a Web site that contains reports, proxy and information statements and other
information regarding registrants, such as QFC, that file electronically with
the SEC. The address of such site is http:// www.sec.gov.
INCORPORATION OF DOCUMENTS BY REFERENCE
The following documents are incorporated herein by reference:
(1) QFC's Annual Report on Form 10-K for the year ended December 30,
1995;
(2) QFC's Quarterly Reports on Form 10-Q for the twelve weeks ended
March 23, 1996, the twelve weeks ended June 15, 1996 and the twelve weeks
ended September 7, 1996; and
(3) QFC's Current Report on Form 8-K dated November 12, 1996, as amended
by Current Reports on Form 8-K/A dated December 24, 1996, December 27, 1996
and February 18, 1997.
All documents filed pursuant to Section 13(a), 13(c), 14 or 15(d) of the
Exchange Act subsequent to the date of this Prospectus Supplement and prior to
the termination of the Common Stock Offering shall be deemed to be incorporated
by reference in this Prospectus Supplement and to be part hereof from the date
of filing of such documents. Any statement contained in a document incorporated
or deemed to be incorporated by reference herein shall be deemed to be modified
or superseded for purposes of this Prospectus Supplement to the extent that a
statement contained herein or in any other subsequently filed document which
also is or is deemed to be incorporated by reference herein modifies or
supersedes such statement. Any such statement so modified or superseded shall
not be deemed, except as so modified or superseded, to constitute a part of this
Prospectus Supplement.
Copies of the above documents (excluding exhibits to such documents, unless
such exhibits are specifically incorporated by reference therein) may be
obtained upon written or oral request without charge by each person to whom this
Prospectus Supplement is delivered from the Treasurer of QFC, 10112 N.E. 10th
Street, Bellevue, Washington 98004 (telephone number (206) 455-3761).
No action has been or will be taken in any jurisdiction by the Company or by
any Underwriter that would permit the public offering of the Common Stock or the
possession or distribution of this Prospectus Supplement or the accompanying
Prospectus in any jurisdiction where action for that purpose is required, other
than in the United States. Persons into whose possession this Prospectus
Supplement comes are required by the Company and the Underwriters to inform
themselves about and to observe any restrictions as to the offering of the
Common Stock and the distribution of this Prospectus Supplement and the
accompanying Prospectus.
S-3
<PAGE>
(This page has been left blank intentionally.)
S-4
<PAGE>
SUMMARY
THE FOLLOWING IS A SUMMARY OF CERTAIN INFORMATION CONTAINED ELSEWHERE HEREIN
OR IN THE DOCUMENTS INCORPORATED BY REFERENCE HEREIN. THIS SUMMARY IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH INFORMATION. UNLESS OTHERWISE EXPRESSLY
STATED OR THE CONTEXT OTHERWISE REQUIRES, (I) THE TERM THE "COMPANY" REFERS TO
QFC AND ITS CONSOLIDATED SUBSIDIARIES (INCLUDING HUGHES AND KUI) AS IF BOTH OF
THE ACQUISITIONS HAVE BEEN CONSUMMATED, (II) THE TERM "QFC" REFERS TO QUALITY
FOOD CENTERS, INC. PRIOR TO CONSUMMATION OF THE ACQUISITIONS AND (III) THE TERM
"KUI" REFERS TO KEITH UDDENBERG, INC. PRIOR TO THE KUI ACQUISITION AND,
THEREAFTER, TO THE SURVIVING CORPORATION IN THE KUI ACQUISITION. EXCEPT AS
OTHERWISE SPECIFIED, REFERENCES TO NUMBERS OF STORES PRIOR TO CONSUMMATION OF
THE ACQUISITIONS ARE AS OF DECEMBER 28, 1996 FOR EACH OF QFC, HUGHES AND KUI.
REFERENCES TO THE NUMBER OF STORES TO BE OPERATED BY THE COMPANY ARE BASED ON
THE DECEMBER 28, 1996 TOTALS, BUT GIVE EFFECT TO THE ACQUISITIONS AND TO THE
ANTICIPATED KUI STORE DIVESTITURES DISCUSSED HEREIN. UNLESS OTHERWISE EXPRESSLY
STATED OR THE CONTEXT OTHERWISE REQUIRES, (I) REFERENCES TO SUPERMARKETS OR THE
SUPERMARKET INDUSTRY EXCLUDE WAREHOUSE STORES, CLUB STORES, DEEP DISCOUNT FOOD
OPERATORS, CONVENIENCE STORES, SUPERCENTERS AND SIMILAR FOOD RETAILERS, WHILE
REFERENCES TO FOOD RETAILERS OR THE FOOD RETAILING INDUSTRY INCLUDE SUCH
WAREHOUSE STORES AND OTHER FOOD RETAILERS, (II) REFERENCES TO THE "SEATTLE/PUGET
SOUND REGION" ARE REFERENCES TO KING, SNOHOMISH, PIERCE AND KITSAP COUNTIES IN
THE STATE OF WASHINGTON AND (III) REFERENCES TO "SOUTHERN CALIFORNIA" ARE
REFERENCES TO THE COUNTIES OF LOS ANGELES, ORANGE, RIVERSIDE, SAN BERNARDINO,
SANTA BARBARA AND VENTURA IN THE STATE OF CALIFORNIA AND EXCLUDE SAN DIEGO
COUNTY. UNLESS OTHERWISE EXPRESSLY INDICATED OR THE CONTEXT OTHERWISE REQUIRES,
ALL INFORMATION HEREIN ASSUMES THAT THE OVER-ALLOTMENT OPTIONS GRANTED IN THE
COMMON STOCK OFFERING ARE NOT EXERCISED. ALL REFERENCES TO "$" OR "DOLLARS" MEAN
UNITED STATES DOLLARS.
THE COMPANY
QFC is a leading operator of premium supermarkets in the Seattle/Puget Sound
region of the State of Washington having expanded its market share from
approximately 6% of total supermarket sales in 1986 to approximately 20% today,
according to management estimates and calculated on a pro forma basis after
giving effect to the KUI Acquisition and the anticipated divestiture of five KUI
stores. Since commencing operations in 1954, QFC has developed a modern store
base in many prime locations, strong name recognition and a reputation for
superior quality and service. During the ten fiscal years ended December 30,
1995, QFC's EBITDA margin has increased from 4.3% to 8.2% (8.5% for the 36 weeks
ended September 7, 1996) which management attributes primarily to the
development of innovative merchandising strategies, such as increased emphasis
on higher margin specialty departments, combined with enhanced cost controls.
With the acquisition of Hughes, QFC will enter into new markets beyond the
Seattle/Puget Sound area and, with the KUI Acquisition, QFC has continued to
expand within the region as part of its overall strategy of becoming a leading
multi-regional operator of premium supermarkets. Upon consummation of the Hughes
Acquisition, the Company will operate 84 stores in the Seattle/Puget Sound
region as well as 56 "Hughes Family Markets" stores in Southern California. On a
pro forma basis after giving effect to the Acquisitions, the Company would have
had sales of approximately $2 billion and EBITDA of approximately $125 million
for the 52 week period ended September 7, 1996.
Management believes that the Company's QFC stores offer customers superior
value by emphasizing an extensive selection of high quality perishable items,
excellent customer service, convenient store locations and hours, a variety of
specialty departments and competitive prices. QFC stores, which average
approximately 31,000 square feet in size, are open seven days a week, 24 hours a
day, and feature a number of specialty departments such as full service
delicatessens, fresh seafood departments, bakery departments with
coffee/espresso bars, and floral departments. Many QFC stores also offer natural
food sections, video rentals, fresh juice bars and pharmacies. In addition, QFC
has been an industry leader in leasing space within its stores to branded
specialty food operators, including STARBUCKS COFFEE, CINNABON WORLD FAMOUS
CINNAMON ROLLS AND NOAH'S NEW YORK BAGELS, as well as to full service banks such
as SEAFIRST BANK. QFC has recently significantly expanded its selection of
prepared foods and "home meal replacement" items which
S-5
<PAGE>
management believes appeal to the increasing convenience orientation of
consumers. Examples include complete hot meals which are ready to serve,
pre-cooked dinners which are ready to heat and eat, "Chef's Express" gourmet
entrees which are specially prepared and ready to cook, and "Northwest Sandwich
Bars" which feature a variety of pasta dishes, specialty and made-to-order hot
and cold sandwiches, pre-made salads and self-serve soup and salad bars.
Management believes that over the last five fiscal years, QFC has achieved
EBITDA margins well in excess of the average for the U.S. supermarket industry,
which management attributes primarily to QFC's superior merchandising and
operating practices combined with favorable customer demographics in the
Seattle/Puget Sound region.
Upon consummation of the Hughes Acquisition, the Company will own and
operate 56 premium supermarkets under the "Hughes Family Markets" name in
Southern California. Management believes that Hughes, which commenced operations
in 1952 with one store, has developed a strong reputation in Southern California
for providing high levels of customer service together with a broad selection of
high-quality meat, produce and other perishables. Management estimates that
Hughes' market share among Southern California supermarkets (excluding San Diego
county) was approximately 5% for 1995. Hughes' stores average approximately
37,000 square feet in size and are generally located near desirable residential
areas. Management believes that Hughes has among the most modern store bases of
any supermarket chain in Southern California due in part to its ongoing store
remodeling program. Hughes supplies the majority of its stores' inventory from
its own centrally located 600,000 square foot warehousing and distribution
facility built in 1993. Hughes also owns a 50% interest in Santee Dairies, Inc.
("Santee"), one of the largest dairy plants in California, which provides dairy
and other products to Hughes, as well as to certain other third parties, under
the well-known "Knudsen" and other labels.
The KUI Acquisition, which closed on February 14, 1997, provides the Company
with desirable store locations primarily in the southern Puget Sound region and
the Olympic Peninsula of the State of Washington, areas in which QFC currently
has a limited presence. Management currently anticipates that it will retain 20
of the 25 stores acquired from KUI. Most of such stores will be converted to the
QFC name and format and remodeled in order to implement QFC's merchandising and
operating practices, although it is expected that the Company (through KUI) may
continue to operate certain of these stores under KUI's current "Stock Market"
name and format. In addition, management believes that the KUI Acquisition
provides the Company with additional critical mass in the Seattle/Puget Sound
region which should improve purchasing and distribution and create economies of
scale. After giving effect to the KUI Acquisition, including the anticipated
divesture of five KUI stores, management estimates that QFC's market share among
supermarkets in the Seattle/Puget Sound region is approximately 20% today. See
"The Acquisitions."
GROWTH STRATEGY
The Company's strategic objective is to become a leading multi-regional
operator of premium supermarkets in order to continue to achieve its goal of
controlled and profitable growth. To this end, the Company plans to capitalize
on its acquisition, merchandising and operating expertise to: (i) increase sales
and enhance margins in existing and newly acquired stores, (ii) realize the
benefits of the Hughes and KUI Acquisitions, (iii) acquire and build new stores
in its existing and contiguous markets and (iv) acquire supermarket chains in
attractive new markets. In order to facilitate this phase of the Company's
development, the Company has hired a new chief executive officer and senior vice
president for corporate development to pursue and integrate acquisitions at a
holding company level, thus allowing current senior management to remain focused
on existing operations. See "The Proposed Reorganization" and "Management."
INCREASE SALES AND ENHANCE MARGINS IN EXISTING AND NEWLY ACQUIRED
STORES. One of the Company's top priorities is to increase sales and enhance
margins in existing and newly acquired stores by: (i) emphasizing higher margin
specialty and convenience items, (ii) expanding sales of proprietary brands
(private label) and (iii) maintaining its high quality store base.
S-6
<PAGE>
- - EMPHASIZE HIGHER MARGIN SPECIALTY AND CONVENIENCE ITEMS. The Company intends
to further develop and implement specialty and convenience-oriented
departments at its stores, which management believes are important tools to
enhance margins, increase foot traffic and build customer loyalty. QFC has
been an industry leader in the development of higher margin products and
services, such as prepared foods and home meal replacement items, which are
geared toward the increasing convenience orientation of consumers.
Management believes that the increase in QFC's EBITDA margins over the past
ten fiscal years has been due in part to sales of items within these
departments, as well as to sales of its seafood, delicatessen, bakery,
floral and other specialty products.
- - EXPAND SALES OF PROPRIETARY BRANDS. QFC recently adopted a program designed
to increase its sales of proprietary brands, which typically carry higher
margins than comparable branded products and at the same time help promote
customer loyalty. After a long-term study of operating practices both in the
U.S. and abroad, QFC developed a three-tier proprietary brands philosophy
which is approximately two-thirds implemented. As a result of this effort,
QFC has increased the percentage of proprietary brand sales from less than
3% at the beginning of fiscal 1996 to approximately 8.5% at the end of
fiscal 1996. This percentage is well below the estimated 1995 supermarket
industry average, which management believes was approximately 15% of sales,
thus providing a significant opportunity for growth of proprietary brand
sales.
- - MAINTAIN ITS HIGH QUALITY STORE BASE. The Company believes that QFC and
Hughes stores are among the most modern and well-maintained in their
respective regions, due in part to their respective remodeling programs.
During the five fiscal years ended December 28, 1996, QFC remodeled or "re-
remodeled" 31 stores, of which 16 were acquired stores which were remodeled
as part of their conversion to the QFC format. Of the 20 stores expected to
be retained in the KUI Acquisition, 13 are presently expected to be
significantly remodeled to facilitate the implementation of QFC's grocery
merchandising and operating practices prior to their conversion to the QFC
name and format. While management believes that the Hughes stores are
generally in good condition, the Company plans to selectively remodel
certain Hughes stores in order to enhance the presentation and merchandising
of meat, seafood, delicatessen items and other perishables and to add or
enhance full-service and leased specialty departments.
REALIZE THE BENEFITS OF THE HUGHES AND KUI ACQUISITIONS. Management
believes that the acquisition of Hughes and KUI will provide the Company with a
number of benefits, including the following:
- - CROSS-FERTILIZATION OF OPERATING CAPABILITIES. Management believes that
significant opportunities exist to improve results of operations at acquired
stores through the implementation of QFC's merchandising and operating
practices. For example, management believes that the Hughes stores will
benefit from the adoption of certain merchandising practices successfully
implemented at QFC stores, including practices relating to the development
of higher margin specialty and convenience oriented departments. The Company
will also seek to expand the use of proprietary brands at Hughes by drawing
on QFC's own recently developed proprietary brands program. Similarly, the
Company expects its QFC stores to benefit from the experience of Hughes'
management in areas such as purchasing, distribution and category
management.
- - PURCHASING AND DISTRIBUTION-RELATED BENEFITS. Management anticipates that
certain benefits will accrue to the Company in the area of purchasing and
distribution as a result of both the Hughes and KUI Acquisitions. For
example, as a result of the KUI Acquisition, management believes that the
Company's larger size in the Seattle/Puget Sound region provides the Company
increased flexibility with regard to supply and distribution options and
should enhance its ability to negotiate lower prices from its suppliers.
Management also expects that the Company's Seattle/Puget Sound operations
will benefit from Hughes' experience in operating its own warehouse and
distribution center. Further, to the extent that the Company adds to its
store base in Southern California, it is expected that it will
S-7
<PAGE>
benefit from excess capacity at the Hughes distribution center, which
management estimates is currently operating at approximately 50% of
capacity.
- - COST SAVINGS AND VOLUME EFFICIENCIES. The Company expects to achieve cost
savings from the elimination of redundant administrative staff, the
consolidation of management information systems and a decreased reliance on
certain outside services as a result of the Acquisitions. In addition, the
Company expects to benefit from savings in the areas of store supplies,
store maintenance, and risk management, among other areas, as a result of
increased purchasing power and volume and operating efficiencies.
ACQUIRE AND BUILD NEW STORES IN ITS EXISTING AND CONTIGUOUS MARKETS. The
Company plans to continue to acquire, and to a lesser extent build, new stores
in its existing and contiguous markets. Management believes that in-market
acquisitions provide an efficient way for the Company to increase sales in its
markets without the resulting increase in overall supermarket capacity caused by
the construction of additional stores. During the past six years, QFC has
acquired and successfully integrated 30 stores from ten operators in the
Seattle/Puget Sound region, including 12 stores acquired from Olson's Food
Stores in 1995. The KUI Acquisition represents a continuation of this strategy
of expanding QFC's presence in its existing and contiguous markets. Over the
last several years, the Seattle/Puget Sound region has been one of the fastest
growing areas in the United States in terms of population, and the KUI
Acquisition not only expands the Company's presence in the region but also
broadens the Company's coverage of the southern portion of the region and the
Olympic Peninsula. See "Business--Market Overview--Seattle/Puget Sound." This
strategy also encompasses expanding into the northern part of the Puget Sound
region as well as into contiguous areas such as eastern Washington and Portland,
Oregon. The Company will seek to implement this strategy in its new Southern
California market as well.
ACQUIRE SUPERMARKET CHAINS IN ATTRACTIVE NEW MARKETS. The Company will
continue to actively seek growth opportunities outside its existing and
contiguous markets by pursuing the acquisition of supermarket chains which are
well-known within their respective markets, have strong growth potential and are
located in geographic areas exhibiting favorable economic and demographic
conditions. For example, Hughes has a reputation for high quality products and
customer service with stores located in Southern California, an area which the
Company believes has recently begun to exhibit growth in jobs and population and
a decrease in unemployment. See "Business--Market Overview--Southern
California." The acquisition of Hughes is the first step in the Company's plans
to become a leading multi-regional operator of premium supermarkets. Management
believes that there are a number of attractive acquisition opportunities in
desirable growth areas, and that these opportunities are attributable in part to
the fragmented nature of a large portion of the domestic supermarket industry.
THE ACQUISITIONS AND THE FINANCINGS
Pursuant to the terms of a definitive merger agreement entered into on
November 20, 1996, QFC will acquire Hughes for approximately $358.8 million
cash, subject to certain adjustments. QFC plans to close the Hughes Acquisition
concurrently with the closing of the Common Stock Offering, the Notes Offering
and the effectiveness of the New Credit Facility (the "Closing"). See "The
Acquisitions."
On February 14, 1997, QFC acquired Keith Uddenberg, Inc. for approximately
$35.3 million in cash and 904,646 shares of Common Stock. The cash portion of
the purchase price was financed, and approximately $24.3 million of then
existing KUI indebtedness was refinanced, with borrowings under QFC's Current
Credit Facility (as defined herein). See "The Acquisitions."
The Company will require approximately $570.3 million in cash to: (i)
finance the Hughes Acquisition, (ii) refinance QFC's bank indebtedness
(including the $59.6 million of indebtedness incurred in connection with the KUI
Acquisition) and (iii) pay fees and expenses. Such funds are expected to be
provided by: (i) the proceeds from the Common Stock Offering, (ii) the proceeds
from the Notes Offering and (iii) borrowings by the Company under an amended and
restated $250 million term loan facility (the "Term
S-8
<PAGE>
Loan Facility"). The Company will also receive an additional $5.2 million which
will be used for general corporate purposes. See "Use of Proceeds" and
"Description of Certain Indebtedness."
The following table sets forth the sources and uses of funds in connection
with the transactions described above.
<TABLE>
<CAPTION>
AMOUNT
-------------------
<S> <C>
(DOLLARS IN
MILLIONS)
SOURCES:
The Common Stock Offering(1)................................................................ $ 175.5
The Notes Offering(2)....................................................................... 150.0
Term Loan Facility.......................................................................... 250.0
------
Total Sources............................................................................. $ 575.5
------
------
USES:
Hughes purchase price....................................................................... $ 358.8
Refinancing of QFC bank debt(3)............................................................. 197.0
Estimated fees and expenses................................................................. 14.5
General corporate purposes.................................................................. 5.2
------
Total Uses................................................................................ $ 575.5
------
------
</TABLE>
- ------------------------
(1) Represents gross proceeds from the Common Stock Offering.
(2) Represents gross proceeds from the Notes Offering.
(3) Includes $59.6 million of indebtedness incurred under the Current Credit
Facility to pay the $35.3 million cash portion of the KUI purchase price and
to refinance $24.3 million of previously existing KUI indebtedness.
THE PROPOSED REORGANIZATION
Following consummation of the Hughes Acquisition, the Company intends to
seek shareholder approval to change its corporate structure (the
"Reorganization"). Subject to obtaining such shareholder approval, upon
consummation of the Reorganization, KUI will remain a subsidiary of QFC, and
each of QFC and Hughes will become a subsidiary of Quality Food Holdings, Inc.,
a Delaware corporation ("Holding Company"), which in turn will be a subsidiary
of Quality Food, Inc., a Delaware corporation ("Parent"), and the current
shareholders of QFC will thereupon generally become shareholders of Parent.
Parent and Holding Company are both currently subsidiaries of QFC.
In connection with the Hughes Acquisition, it is expected that the Company
will enter into the Term Loan Facility, an amended and restated $125 million
revolving credit facility (the "Revolving Credit Facility") and a new $225
million reducing revolving credit facility (the "Acquisition Facility" and,
together with the Term Loan Facility and the Revolving Credit Facility, the "New
Credit Facility"). Although QFC will initially be the sole borrower under the
New Credit Facility, in the event the proposed Reorganization occurs it is
expected that Holding Company will become the borrower under both the Revolving
Credit Facility and the Acquisition Facility, while QFC will remain the borrower
under the Term Loan Facility. It is expected that Hughes, KUI, Holding Company
and Parent will initially guarantee the Company's borrowings under the New
Credit Facility. In connection with the Notes Offering, QFC will remain the
obligor on the Notes after the Reorganization and each of Hughes, KUI and
Holding Company will continue to guarantee QFC's obligations thereunder. Parent
will not be a guarantor of the Notes either before or after the Reorganization.
See "The Proposed Reorganization" and "Description of Certain Indebtedness."
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<PAGE>
RECENT DEVELOPMENTS
QFC OPERATING RESULTS FOR THE 16 WEEKS ENDED DECEMBER 28, 1996. QFC's sales
for the 16 week period ended December 28, 1996 increased 7.9% to $258.1 million,
as compared to sales of $239.3 million for the comparable period in 1995. Same
Store Sales (as defined herein) increased 6.0% during the period with estimated
food price inflation of less than 1.0%. The sales increase for the period
reflected strong sales increases in two replacement stores, sales from two
stores acquired in October, higher sales in stores remodeled during 1996 and
improved Same Store Sales. The sales increase was also partially due to strong
sales arising from snowstorms in November and December.
QFC's net earnings for the 16 week period ended December 28, 1996 were $8.6
million, an increase of 31.7% from $6.5 million for the comparable period in
1995. Earnings per share for the period were $0.57, an increase of 26.7% from
$0.45 for the comparable period in 1995.
QFC's EBITDA for the 16 week period ended December 28, 1996 increased 13.5%
to $22.6 million, or 8.7% of sales, as compared to $19.9 million, or 8.3% of
sales, for the comparable period in 1995. Operating income was $16.2 million, or
6.3% of sales, a 16.8% increase over the comparable period in 1995.
During 1996, QFC reduced its outstanding long-term debt (including current
portion) by $19.5 million to $145 million at December 28, 1996, resulting in a
decrease in net interest expense of $855,000 for the fourth quarter of 1996
compared to the comparable period in 1995.
QFC OPERATING RESULTS FOR THE 52 WEEKS ENDED DECEMBER 28, 1996. QFC's sales
for the 52 week period ended December 28, 1996 were $805.3 million, an increase
of 10.3% from fiscal year 1995. Same Store Sales increased 3.3% from fiscal year
1995 with no significant food price inflation in fiscal 1996.
QFC's net earnings for fiscal year 1996 increased 25.7% to $25.4 million, or
$1.71 per share, as compared to $20.2 million, or $1.28 per share, for fiscal
year 1995. The increase in net earnings for fiscal 1996 reflected a $6.2 million
increase in operating income and a $1.4 million reduction in other expense due
to a one-time charge recorded in the first fiscal quarter of 1995 relating to
the Recapitalization (as defined herein). Excluding the $1.4 million charge, net
earnings and earnings per share for 1995 would have been $21.6 million and $1.37
per share, respectively.
QFC's EBITDA for the year increased 16.1% to $69.1 million, or 8.6% of
sales, as compared to $59.6 million, or 8.2% of sales, for fiscal year 1995 and
operating income increased 14.5% to $49.0 million, as compared to $42.8 million
for fiscal year 1995.
QFC RESULTS OF OPERATIONS. The following table sets forth certain financial
information derived from the audited financial statements of QFC for the 52
weeks ended December 30, 1995, as well as certain
S-10
<PAGE>
unaudited financial formation for QFC for the 52 weeks ended December 28, 1996
and the 16 weeks ended December 30, 1995 and December 28, 1996.
<TABLE>
<CAPTION>
52 WEEKS ENDED 16 WEEKS ENDED
------------------------------------ ------------------------------------
<S> <C> <C> <C> <C>
DECEMBER 30, 1995 DECEMBER 28, 1996 DECEMBER 30, 1995 DECEMBER 28, 1996
----------------- ----------------- ----------------- -----------------
<CAPTION>
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Sales............................... $ 729,856 $ 805,281 $ 239,322 $ 258,115
Cost of Sales and Related Occupancy
Expenses.......................... 550,434 603,947 181,257 193,399
Marketing, General and
Administrative Expenses........... 136,644 152,337 44,169 48,486
-------- -------- -------- --------
Operating Income.................... 42,778 48,997 13,896 16,230
Interest Income..................... 501 467 76 165
Interest Expense.................... (9,639) (9,890) (3,754) (2,988)
Other Expense....................... (1,400) -- -- --
-------- -------- -------- --------
Earnings before income taxes........ 32,240 39,574 10,218 13,407
Taxes on Income..................... 12,023 14,156 3,670 4,784
-------- -------- -------- --------
Net Earnings........................ $ 20,217 $ 25,418 $ 6,548 $ 8,623
-------- -------- -------- --------
-------- -------- -------- --------
Earnings Per Share.................. $ 1.28 $ 1.71 $ 0.45 $ 0.57
Weighted average shares
outstanding....................... 15,830 14,890 14,548 15,140
EBITDA(1)........................... $ 59,567 $ 69,150 $ 19,895 $ 22,584
EBITDA Margin(1).................... 8.2% 8.6% 8.3% 8.7%
</TABLE>
- ------------------------------
(1) See notes (4) and (5) under "--Summary Historical Financial Data of QFC" for
the definitions of EBITDA and EBITDA margin.
S-11
<PAGE>
THE COMMON STOCK OFFERING
<TABLE>
<S> <C>
Common Stock offered by the Company.......... 4,500,000 shares
Common Stock offered for sale in:
The U.S. Offering.......................... 3,600,000 shares
The International Offering................. 900,000 shares
Total Common Stock Offered............... 4,500,000 shares
Common Stock to be outstanding after the
Common Stock Offering and the
Acquisitions............................... 20,142,560 shares(1)
New York Stock Exchange symbol............... "XQ."
Use of Proceeds.............................. To provide part of the financing necessary to
pay the total cash consideration payable in
connection with the Hughes Acquisition and to
refinance QFC's bank indebtedness (including
indebtedness incurred in connection with the
KUI Acquisition). See "Use of Proceeds."
Dividend Policy.............................. QFC does not currently pay cash dividends on
its Common Stock and presently intends to
retain available funds to finance the growth
and operations of the business. See "Price
Range of Common Stock and Dividend Policy."
Risk Factors................................. Prospective investors should carefully
consider all the information set forth and
incorporated by reference herein and, in
particular, should evaluate the specific
factors set forth under "Risk Factors" before
purchasing any of the shares offered hereby.
</TABLE>
- ------------------------
(1) Includes the 904,646 shares of Common Stock issued in connection with the
KUI Acquisition and 70,000 shares to be issued in connection with the
acquisition of two stores in late 1996. Does not include 2,178,191 shares of
Common Stock issuable upon the exercise of outstanding stock options.
S-12
<PAGE>
SUMMARY UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA OF THE COMPANY
The following table sets forth summary unaudited pro forma condensed
consolidated financial data of the Company for the fiscal year ended December
30, 1995 and for the 52 weeks ended September 7, 1996. The pro forma operating
and other data for the fiscal year ended December 30, 1995 combines the results
of operations of QFC for such fiscal year with the results of operations of
Hughes for its fiscal year ended March 3, 1996 and the results of operations of
KUI for its fiscal year ended December 30, 1995 and gives effect to each of the
following transactions as if such transactions had occurred on January 1, 1995:
(i) the Hughes Acquisition and certain related transactions; (ii) Hughes' sale
in November 1996 of a 1% equity interest in Santee, which, prior to the sale,
was a 51%-owned subsidiary of Hughes, to Stater Bros. Markets ("Stater"),
resulting in Santee ceasing to be a consolidated subsidiary of Hughes; (iii)
KUI's spin off of certain assets and liabilities, primarily related to
non-grocery operations, prior to the KUI Acquisition; (iv) the KUI Acquisition
and certain related transactions; (v) the application of the estimated net
proceeds from the Common Stock Offering and the Notes Offering (the "Offerings")
and borrowings under the New Credit Facility to finance the Hughes Acquisition
and to refinance bank debt of QFC expected to be outstanding at the time of the
Closing (including indebtedness which was incurred in connection with the KUI
Acquisition); and (vi) QFC's proposed divestiture of five of the recently
acquired KUI stores. The pro forma operating and other data for the 52 weeks
ended September 7, 1996 combines results of operations of QFC for the 52 weeks
ended September 7, 1996 with the results of operations of Hughes for the 52
weeks ended September 29, 1996 and the results of operations of KUI for the 52
weeks ended September 28, 1996 and gives effect to the transactions described
above as if such transactions had occurred on September 10, 1995. The pro forma
balance sheet data as of September 7, 1996 combines the balance sheet data of
QFC as of September 7, 1996 with the balance sheet data of Hughes as of
September 29, 1996 and the balance sheet data of KUI as of September 28, 1996
and gives effect to the transactions described above as if such transactions had
been competed as of September 7, 1996.
The pro forma financial data set forth below are based upon a number of
assumptions and estimates, are subject to a number of uncertainties, and do not
purport to be indicative of the actual financial position or results of
operations that would have been achieved had the above described transactions in
fact occurred on the dates indicated, nor do they purport to be indicative of
the results of operations or financial condition that may be achieved in the
future. The following pro forma financial data should be read in conjunction
with "Unaudited Pro Forma Condensed Consolidated Financial Statements,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the historical financial statements of QFC, Hughes and KUI and
related notes thereto included or incorporated by reference herein.
S-13
<PAGE>
SUMMARY UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA OF THE COMPANY
(CONTINUED)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED 52 WEEKS ENDED
DECEMBER 30, 1995 SEPTEMBER 7, 1996
----------------- -----------------
<S> <C> <C>
(DOLLARS IN THOUSANDS, EXCEPT PER
SHARE AMOUNTS)
OPERATING DATA:
Sales..................................................................... $ 1,985,718 $ 2,076,197
Gross Profit.............................................................. 463,297 490,155
Marketing, General and Administrative Expenses............................ 393,451 408,018
Operating Income.......................................................... 69,846 82,137
Net Interest Expense(1)................................................... 33,550 33,210
Net Earnings.............................................................. 18,588 26,550
Earnings Per Share(2)..................................................... 0.88 1.32
Ratio of Earnings to Fixed Charges(3)..................................... 1.8x 2.1x
OTHER DATA:
EBITDA(4)................................................................. $ 107,453 $ 124,682
EBITDA Margin(5).......................................................... 5.4% 6.0%
Depreciation and Amortization............................................. $ 42,697 $ 47,456
Ratio of Net Debt to EBITDA(6)............................................ -- 3.3x
Ratio of EBITDA to Net Interest Expense................................... -- 3.8x
BALANCE SHEET DATA (AT END OF PERIOD):
Cash and Cash Equivalents................................................. $ 16,404
Net Working Capital....................................................... 8,580
Total Assets.............................................................. 888,950
Total Debt (including current portion).................................... 432,731
Shareholders' Equity...................................................... 267,561
</TABLE>
- ------------------------------
(1) Net of interest income; also excludes amortization of deferred financing
costs of $708,800 for each of the periods presented.
(2) Earnings per share have been calculated on a fully-diluted basis giving
effect to (i) 4.5 million shares to be sold in the Common Stock Offering and
(ii) 904,646 shares issued in connection with the KUI Acquisition.
(3) For purposes of these ratios, (i) earnings have been calculated by adding
interest expense and the estimated interest portion of rentals to earnings
before income taxes and (ii) fixed charges are comprised of interest expense
and the estimated interest portion of rentals.
(4) EBITDA is defined as net earnings before interest, income taxes,
depreciation, amortization, LIFO inventory charges, and, if applicable,
equity earnings (losses) from subsidiaries, and non-recurring and
extraordinary items. EBITDA excludes union, pension and benefit credits of
$7.2 million and $7.7 million recorded by Hughes for the fiscal year ended
March 3, 1996 and the 52 weeks ended September 29, 1996, respectively.
EBITDA is a measure commonly used in the grocery industry and is presented
to assist in understanding the Company's pro forma operating results. EBITDA
is not intended to represent cash flow from operations as defined by
generally accepted accounting principles ("GAAP") and should not be
considered as an alternative to cash flow as a measure of liquidity or as an
alternative to net earnings as an indicator of operating performance. EBITDA
is included herein because management believes that certain investors find
it to be a useful tool for measuring the Company's ability to service its
debt.
(5) EBITDA margin is calculated by dividing EBITDA by sales, in each case for
the applicable period.
(6) Net Debt is defined as Total Debt less cash and cash equivalents, in each
case at the end of the applicable period.
S-14
<PAGE>
SUMMARY HISTORICAL FINANCIAL DATA OF QFC
The following table sets forth summary historical financial data of QFC as
of and for each of the five fiscal years in the period ended December 30, 1995
and as of and for the 36 weeks ended September 7, 1996 and September 9, 1995.
Data as of and for each of the three fiscal years in the period ended December
30, 1995 (except for data regarding stores open at the end of period, Same Store
Sales increase (decrease) and total square footage) have been derived from
audited financial statements of QFC, which are included herein. Data as of and
for each of two fiscal years ended December 26, 1992 and December 28, 1991
(except for data regarding stores open at the end of period, Same Store Sales
increase (decrease) and total square footage) have been derived from audited
financial statements of QFC which are not included herein. Data as of and for
the 36 weeks ended September 7, 1996 and September 9, 1995 have been derived
from unaudited financial statements of QFC which, in the opinion of management,
include all necessary adjustments, consisting only of normal recurring
adjustments, necessary for fair presentation of the information. Data as of and
for the 36 weeks ended September 7, 1996 and September 9, 1995 do not purport to
be indicative of results to be expected for the full fiscal year. The following
information is qualified by reference to, and should be read in conjunction
with, "Unaudited Pro Forma Condensed Consolidated Financial Statements,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the historical statements of QFC and related notes thereto
included or incorporated by reference herein.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
36 WEEKS 36 WEEKS
ENDED ENDED
DECEMBER 28, DECEMBER 26, DECEMBER 25, DECEMBER 31, DECEMBER 30, SEPTEMBER 9, SEPTEMBER 7,
1991 1992 1993 1994(1) 1995(2) 1995(2) 1996
------------- ------------- ------------ ------------ ------------ ------------ ------------
<CAPTION>
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Sales............... $ 395,151 $ 460,107 $ 518,260 $ 575,879 $ 729,856 $ 490,534 $ 547,166
Gross Profit........ 99,063 116,989 131,365 145,168 179,422 121,357 136,617
Marketing, General
and
Administrative
Expenses......... 69,076 80,144 92,468 105,956 136,645 92,476 103,850
Operating Income.... 29,987 36,845 38,897 39,212 42,777 28,881 32,767
Interest Expense.... -- -- -- -- 9,639 5,885 6,901
Net Earnings........ 20,647 25,076 25,994 26,376 20,216 13,669 16,795
Earnings Per Share.. 1.06 1.28 1.33 1.34 1.28 0.83 1.14
Ratio of Earnings to
Fixed
Charges(3)....... 22.4x 22.7x 17.6x 15.7x 3.3x 3.5x 3.3x
OTHER DATA:
EBITDA(4)........... $ 36,797 $ 44,466 $ 48,205 $ 50,817 $ 59,567 $ 39,671 $ 46,566
EBITDA Margin(5).... 9.3% 9.7% 9.3% 8.8% 8.2% 8.1% 8.5%
Depreciation and
Amortization..... $ 6,511 $ 7,782 $ 9,283 $ 11,605 $ 16,169 $ 10,715 $ 13,589
Capital
Expenditures..... 25,900 26,800 43,000 28,200 89,100 80,850 25,000
Stores Open at End
of Period........ 30 33 38 45 62 61 62
Same Store Sales
Increase
(Decrease)(6).... 5.9% 6.5% 4.0% 0.4% (1.5%) (1.3%) 2.1%
Total Square
Footage.......... 770,000 907,000 1,080,000 1,319,000 1,928,000 1,873,000 1,990,000
BALANCE SHEET DATA (AT
END OF PERIOD):
Net Working
Capital.......... $ 6,325 $ 18,722 $ 14,329 $ 23,776 $ 5,303 $ 3,950 $ (16,903)
Total Assets........ 115,922 150,974 181,275 207,914 282,878 278,327 293,610
Total Debt
(including
current
portion)......... -- -- -- -- 164,500 168,000 150,000
Shareholders'
Equity........... 81,169 108,345 133,620 158,178 45,368 38,138 64,407
</TABLE>
- --------------------------
(1) Fiscal year ended December 31, 1994 was a 53 week fiscal year.
S-15
<PAGE>
(2) Fiscal year ended December 30, 1995 and 36 weeks ended September 9, 1995
data include a one-time charge of $1.4 million, or $.09 per share, resulting
from the Recapitalization (as defined herein) completed in March 1995.
(3) For purposes of these ratios, (i) earnings have been calculated by adding
interest expense and the estimated interest portion of rentals to earnings
before income taxes and (ii) fixed charges are comprised of interest expense
and the estimated interest portion of rentals.
(4) EBITDA is defined as net earnings before interest, income taxes,
depreciation, amortization, LIFO inventory charges, and, if applicable,
equity earnings (losses) from subsidiaries, and non-recurring and
extraordinary items. EBITDA is a measure commonly used in the grocery
industry and is presented to assist in understanding the Company's operating
results. EBITDA is not intended to represent cash flow from operations as
defined by GAAP and should not be considered as an alternative to cash flow
as a measure of liquidity or as an alternative to net earnings as an
indicator of operating performance. EBITDA is included herein because
management believes that certain investors find it to be a useful tool for
measuring the Company's ability to service its debt.
(5) EBITDA margin is calculated by dividing EBITDA by sales, in each case for
the applicable period.
(6) Same Store Sales exclude sales in stores opened or acquired during the
previous 12 months and the 53rd week of fiscal 1994.
S-16
<PAGE>
SUMMARY HISTORICAL FINANCIAL DATA OF HUGHES
The following table sets forth summary historical financial data of Hughes
and its consolidated subsidiaries as of and for the five fiscal years ended
March 3, 1996, as of and for the seven months ended September 24, 1995 and as of
and for the seven months ended September 29, 1996. Data as of and for the five
fiscal years ended March 3, 1996 (except for data regarding stores open at end
of period, Same Store Sales increase (decrease) and total square footage) have
been derived from consolidated financial statements of Hughes audited by Arthur
Andersen LLP, independent certified public accountants. Data as of and for the
seven months ended September 24, 1995 and the seven months ended September 29,
1996 have been derived from unaudited consolidated statements of Hughes which,
in the opinion of Hughes' management, include all necessary adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of the information. Data as of and for the seven months ended
September 29, 1996 do not purport to be indicative of results to be expected for
the full fiscal year. During each of the periods presented, Santee was a
51%-owned subsidiary of Hughes. In November 1996, Hughes sold a 1% interest in
Santee, resulting in Santee ceasing to be a consolidated subsidiary of Hughes.
The following information should be read in conjunction with "Unaudited Pro
Forma Condensed Consolidated Financial Statements," "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the historical
consolidated financial statements of Hughes and related notes thereto included
or incorporated by reference herein.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
----------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
SEVEN SEVEN
MONTHS MONTHS
ENDED ENDED
MARCH 1, FEBRUARY 28, FEBRUARY 27, FEBRUARY 26, MARCH 3, SEPTEMBER 24, SEPTEMBER 29,
1992 1993 1994 1995 1996(1) 1995 1996
--------- ------------ ------------ ------------ ----------- ------------- -------------
(DOLLARS IN THOUSANDS)
OPERATING DATA:
Sales................... $1,099,713 $1,087,274 $1,083,709 $1,110,947 $1,147,447 $ 647,486 $ 675,432
Gross Profit............ 206,556 225,024 229,084 226,085 245,496 138,414 145,522
Selling, General and
Administrative
Expense............... 181,209 209,918 206,289 209,211 215,234 122,631 126,493
Operating Income........ 25,347 15,106 22,795 16,874 30,262 15,783 19,029
Interest Expense........ 3,598 1,149 4,598 4,664 4,335 2,595 2,100
Net Income.............. 14,608 8,677 11,224 8,374 16,184 8,534 10,399
OTHER DATA:
EBITDA(2)............... $ 42,807 $ 33,379 $ 40,794 $ 36,929 $ 42,439 $ 22,552 $ 29,037
EBITDA Margin(3)........ 3.9% 3.1% 3.8% 3.3% 3.7% 3.5% 4.3%
Depreciation and
Amortization.......... $ 15,597 $ 17,504 $ 19,310 $ 21,313 $ 19,571 $ 9,309 $ 12,111
Capital Expenditures.... 15,773 57,862 31,701 36,063 19,633 3,848 30,939
Stores Open at End of
Period................ 52 51 51 53 54 54 55
Same Store Sales
Increase
(Decrease)(4)......... (0.7%) (1.7%) 0.7% 1.1% (1.4%) (0.5%) 0.6%
Total Square Footage.... 1,852,000 1,855,000 1,858,000 1,942,000 1,986,000 1,986,000 2,038,000
BALANCE SHEET DATA (AT
END OF PERIOD):
Net Working Capital..... $ 24,237 $ 8,192 $ 16,526 $ 8,628 $ 16,528 $ 8,404 $ (11,448)
Total Assets............ 258,632 270,611 300,941 316,728 316,499 311,874 315,709
Total Debt (including
current portion)...... 28,516 30,303 37,247 41,984 27,463 23,784 12,248
Shareholders' Equity.... 112,756 121,077 131,289 137,975 151,544 144,590 160,771
</TABLE>
- --------------------------
(1) Fiscal year ended March 3, 1996 was a 53-week fiscal year.
(2) EBITDA is defined as net earnings before interest, income taxes,
depreciation, amortization, LIFO inventory charges, and, if applicable,
equity earnings (losses) from subsidiaries, and non-recurring and
extraordinary items. EBITDA excludes union, pension and benefit credits of
$7.2 million, $3.0 million and $1.2 million recorded by Hughes for the
fiscal year ended March 3,
S-17
<PAGE>
1996, the fiscal year ended February 26, 1995 and the fiscal year ended
February 27, 1994, respectively, and pension and benefit credits of $2.4
million and $3.0 million recorded by Hughes for the seven months ended
September 24, 1995 and the seven months ended September 29, 1996,
respectively. EBITDA is a measure commonly used in the grocery industry and
is presented to assist in understanding Hughes' operating results. EBITDA is
not intended to represent cash flow from operations as defined by GAAP and
should not be considered as an alternative to cash flow as a measure of
liquidity or as an alternative to net earnings as an indicator of operating
performance. EBITDA is included herein because management believes that
certain investors find it to be a useful tool for measuring the Company's
ability to service its debt.
(3) EBITDA margin is calculated by dividing EBITDA by sales, in each case for
the applicable period.
(4) Same Store Sales exclude sales in stores opened or acquired during the
previous 12 months and the 53rd week of fiscal 1996.
S-18
<PAGE>
RISK FACTORS
IN ADDITION TO THE OTHER INFORMATION SET FORTH AND INCORPORATED BY REFERENCE
HEREIN, PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE FOLLOWING
INFORMATION IN EVALUATING THE COMPANY AND ITS BUSINESS BEFORE MAKING AN
INVESTMENT IN THE SECURITIES OFFERED HEREBY. THE INFORMATION CONTAINED AND
INCORPORATED BY REFERENCE 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, 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 OR INCORPORATED
BY REFERENCE HEREIN DO NOT PURPORT TO BE PREDICTIONS OF FUTURE EVENTS OR
CIRCUMSTANCES AND MAY NOT BE REALIZED. FORWARD-LOOKING STATEMENTS CAN BE
IDENTIFIED BY, AMONG OTHER THINGS, THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH
AS "BELIEVES," "EXPECTS," "MAY," "WILL," "SHOULD," "SEEKS," "PRO FORMA" OR
"ANTICIPATES," OR THE NEGATIVE THEREOF, OR OTHER VARIATIONS THEREON OR
COMPARABLE TERMINOLOGY, OR BY DISCUSSIONS OF STRATEGY OR INTENTIONS.
RISKS RELATING TO ACQUISITION STRATEGY
At December 28, 1996, QFC had 64 stores in the Seattle/Puget Sound region of
the State of Washington. After giving effect to the Acquisitions and the
anticipated divestiture of certain KUI stores, the Company will have a total of
140 stores in both the Seattle/Puget Sound region and in Southern California.
Although Hughes' management is expected to remain intact and although QFC has
recently added senior management, this significant increase in the size of the
Company's operations after the Acquisitions will substantially increase the
demands placed upon the Company's management, including demands resulting from
the need to integrate the accounting systems, management information systems and
other operations of Hughes and KUI with those of QFC, and the Company is unable
to predict the effect of either Acquisition on its results of operations,
including earnings per share. In that regard, after giving effect to the
Acquisitions, the Financings and certain related transactions, the Company's pro
forma earnings per share for the 36 weeks ended September 7, 1996 and the fiscal
year ended December 30, 1995 would have been lower than the Company's historical
earnings per share for those periods. See "Unaudited Pro Forma Condensed
Consolidated Financial Statements." Failure to effectively integrate the
operations of the acquired businesses with those of QFC could have a material
adverse effect on the Company.
A substantial portion of QFC's growth over the last several years has been
attributable to acquisitions. Further, a principal component of the Company's
strategy is to continue to grow profitably and in a controlled manner in both
existing and new markets by acquiring new stores, acquiring other regional
supermarket chains and remodeling newly-acquired and existing stores. The
Company's future growth will be dependent upon a number of factors, including
the Company's ability to identify acceptable acquisition candidates, consummate
acquisitions on favorable terms, successfully integrate acquired businesses,
expand its customer base at existing and acquired locations and obtain financing
to support expansion. There can be no assurance that the Company will be
successful in implementing its acquisition strategy, that growth will continue
at historical levels or at all, or that any expansion will improve operating
results, although in order to facilitate this phase of its development the
Company has hired a new chief executive officer and a senior vice president for
corporate development to pursue and integrate acquisitions at a holding company
level, thus allowing current senior management to remain focused on existing
operations. The failure to identify, acquire and integrate acquired businesses
effectively could adversely affect the Company's operating prospects for future
growth.
S-19
<PAGE>
SUBSTANTIAL LEVERAGE
Upon consummation of the Acquisitions and the Financings, the Company will
be highly leveraged. As of September 7, 1996, on a pro forma basis after giving
effect to the Acquisitions and the Financings and the application of the
estimated net proceeds therefrom as described under "Use of Proceeds" as if such
transactions had occurred on such date, the Company and its consolidated
subsidiaries would have had an aggregate of $432.7 million of outstanding
consolidated indebtedness and consolidated shareholders' equity of $267.6
million. See "Capitalization." In addition, the Company intends to continue to
seek to acquire additional supermarket chains and supermarkets and, to the
extent that the Company acquires entities with existing debt or makes
acquisitions which are financed with the proceeds from borrowings, the Company's
outstanding indebtedness will increase, perhaps substantially.
The Company's high degree of leverage could have important consequences to
investors, including the following: (i) the Company's ability to obtain
additional financing for working capital, capital expenditures, acquisitions,
general corporate purposes or other purposes may be impaired in the future; (ii)
a substantial portion of the Company's cash flow from operations must be
dedicated to the payment of principal and interest on its indebtedness, thereby
reducing the funds available to the Company for other purposes; (iii) certain of
the Company's borrowings are and will continue to be at variable rates of
interest (including borrowings under the New Credit Facility), which will expose
the Company to the risk of increased interest rates; (iv) the Company may be
substantially more leveraged than certain of its competitors, which may place
the Company at a competitive disadvantage; and (v) the Company's substantial
degree of leverage may limit its flexibility to adjust to changing market
conditions, reduce its ability to withstand competitive pressures and make it
more vulnerable to a downturn in general economic conditions or its business.
See "Description of Certain Indebtedness."
ABILITY TO SERVICE DEBT
The Company's ability to make scheduled payments or to refinance its
obligations with respect to its indebtedness will depend on its financial and
operating performance, which in turn will be subject to economic conditions and
to financial, business and other factors beyond its control. If the Company's
cash flow and capital resources are insufficient to fund its debt service
obligations, the Company may be forced to reduce or delay planned expansion and
capital expenditures, sell assets, obtain additional equity capital or
restructure its debt. There can be no assurance that the Company's operating
results, cash flow and capital resources will be sufficient for payment of its
indebtedness in the future. In the absence of such operating results and
resources, the Company could face substantial liquidity problems and might be
required to dispose of material assets or operations to meet its debt service
and other obligations, and there can be no assurance as to the timing of such
sales or the proceeds that the Company could realize therefrom. In addition,
because the Company's obligations under the New Credit Facility will bear
interest at floating rates, an increase in interest rates could adversely
affect, among other things, the Company's ability to meet its debt service
obligations. The Company will be required to make scheduled principal payments
under the New Credit Facility commencing in June 1998. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" and "Description of Certain
Indebtedness."
RESTRICTIVE DEBT COVENANTS; COMPLIANCE WITH DEBT INSTRUMENTS
The New Credit Facility and the Indenture relating to the Notes (the
"Indenture") will contain a number of significant covenants that, among other
things, will restrict the ability of the Company (and in the case of the New
Credit Facility, if the proposed Reorganization is consummated, Parent) and its
subsidiaries to dispose of assets, incur additional indebtedness, repay other
indebtedness, pay dividends, create liens on assets, enter into leases, make
investments, loans or advances, make acquisitions, engage in mergers or
consolidations, engage in certain transactions with affiliates and otherwise
restrict corporate
S-20
<PAGE>
activities. In addition, under the New Credit Facility, the Company (and, if the
proposed Reorganization is consummated, Parent) 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. Moreover, a Change of Control (as
defined in the Indenture relating to the Notes) and similar events will
constitute events of default under the New Credit Facility. It is expected that
the New Credit Facility will initially be secured by the capital stock of
Holding Company, Hughes and KUI and the pledge of certain intercompany
indebtedness and that after the Reorganization (if it occurs), will be secured
by the capital stock of Holding Company, QFC, Hughes and KUI and the pledge of
certain intercompany indebtedness. See "Description of Certain Indebtedness."
Likewise, the instruments and agreements governing other indebtedness which the
Company and its subsidiaries may incur in the future may also contain covenants
restricting their activities or requiring compliance with specified financial
ratios and tests.
The Company's ability to remain in compliance with certain such agreements
and covenants will depend upon its results of operations and may be affected by
events beyond its control, including economic, financial and industry
conditions. Accordingly, there can be no assurance that the Company will remain
in compliance with such agreements and covenants. In the event of a default
under the New Credit Facility or the Indenture or under instruments or
agreements relating to any other indebtedness of the Company or its
subsidiaries, the holders of such indebtedness generally will be able to declare
all such indebtedness, together with accrued interest thereon, to be due and
payable immediately and, in the case of collateralized indebtedness, to proceed
against their collateral. In addition, default under one debt instrument could
in turn permit lenders under other debt instruments to declare borrowings
outstanding thereunder to be due and payable pursuant to cross-default clauses.
Moreover, upon the occurrence of an event of default under the New Credit
Facility, the commitment of the lenders thereunder to make further loans to the
Company could be terminated. Accordingly, the occurrence of a default under any
debt instrument could have a material adverse effect on the Company. See also
"--Risks Relating to Santee Dairies" below.
The Company anticipates that under the New Credit Facility, if the
Reorganization occurs, each of Parent and Holding Company will remain subject to
the restrictive covenants and agreements to which it was subject, prior to the
Reorganization, as a subsidiary of QFC. Likewise, the Company anticipates that,
following the Reorganization, the New Credit Facility will be secured by the
capital stock of Holding Company, QFC, Hughes and KUI and the pledge of certain
intercompany indebtedness. In addition, if the Reorganization occurs and Parent
and/or Holding Company thereafter incurs indebtedness, the foregoing discussion
would apply generally with respect to any such indebtedness.
GEOGRAPHIC CONCENTRATION
All of QFC's and KUI's current stores are located in the Seattle/Puget Sound
region of the State of Washington and, following the consummation of the Hughes
Acquisition, a substantial percentage of the Company's business will be
conducted in Southern California. Southern California began to experience a
significant economic downturn in 1991, although management believes that the
region has recently begun a recovery. A significant economic downturn in
Southern California, or in the Seattle/Puget Sound region, in general, could
have a material adverse effect on the Company. See "Business--Market Overview."
COMPETITION
The supermarket industry is highly competitive and characterized by narrow
profit margins. The Company's competitors include national and regional
supermarket chains, independent and specialty grocers, drug and convenience
stores and the newer "alternative format" food stores, including warehouse-style
stores, club stores, deep discount stores and "supercenters." Supermarket chains
and other food retailers generally compete on the basis of location, quality of
products, service, price, product variety and
S-21
<PAGE>
store condition. The Company regularly monitors its competitors' prices and
adjusts its prices and marketing strategy as management deems appropriate in
light of existing conditions. Accordingly, price reductions necessary to respond
to competitive pressures may from time to time adversely affect the Company's
results of operations. Some of the Company's competitors have substantially
greater financial and other resources than the Company and could use those
resources to take steps which could adversely affect the Company's competitive
position and results of operations. In that regard, during the fourth quarter of
fiscal 1994 and through fiscal 1995, the Company experienced an unusually large
number of new store openings and store remodelings by its competitors near its
existing stores in the Seattle/Puget Sound region, which resulted in reduced
sales in certain of the Company's stores. Fewer such openings occurred during
fiscal 1996, although the Company anticipates several competitive openings
during 1997 and thereafter, which could adversely affect the Company. The
Company's ability to remain competitive in its markets will in part depend on
its ability to remodel and update its stores in response to remodelings and new
store openings by its competitors, which in turn will require the continued
availability of financing. See "Business--Competition."
ENVIRONMENTAL MATTERS
The Company is subject to federal, state and local laws, regulations and
ordinances that (i) govern activities or operations that may have adverse
environmental effects, such as discharges to air and water, as well as handling
and disposal practices for solid and hazardous wastes and (ii) impose liability
for the costs of cleaning up, and certain damages resulting from, sites of past
spills, disposals or other releases of hazardous materials (together,
"Environmental Laws"). In particular, under applicable Environmental Laws, the
Company may be responsible for remediation of environmental conditions and may
be subject to associated liabilities (including liabilities resulting from
lawsuits brought by private litigants) relating to its stores and the land on
which its stores are situated, regardless of whether the Company leases or owns
the stores or land in question and regardless of whether such environmental
conditions were created by the Company or by a prior owner or tenant. Although
the Company typically conducts a limited environmental review prior to acquiring
or leasing new stores or raw land, there can be no assurance that environmental
conditions relating to prior, existing or future stores or store sites
(including those acquired or to be acquired in the Acquisitions) will not have a
material adverse effect on the Company. See "Business-- Environmental Matters."
LABOR RELATIONS
After giving effect to the Acquisitions, approximately 92% of the Company's
employees will be unionized. While QFC believes that its relations with its
employees are good and that the relationship among Hughes and KUI and their
respective employees have been good, there can be no assurance that a labor
dispute or disturbance will not occur in the future, which could have a material
adverse effect on the Company. Immediately after the Acquisitions, approximately
2.5% of the Company's employees will be covered by collective bargaining
agreements which expire, or are subject to renegotiation, at various times in
1997, including two labor contracts covering approximately 200 employees of
Hughes which have expired and are under discussion with the applicable unions.
There can be no assurance that new agreements will be reached on terms
satisfactory to the Company or that labor costs will not increase, perhaps
substantially, as a result thereof. See "Business--Employees and Labor
Relations."
RESTRICTIONS ON PAYMENT OF DIVIDENDS
The Company does not currently pay cash dividends on its Common Stock and
presently intends to retain available funds to finance the growth and operations
of its business. Subject to certain exceptions, it is expected that the New
Credit Facility will restrict the payment of cash dividends on the Common Stock,
and the Indenture to be entered into in connection with the Notes Offering will
also restrict the making of
S-22
<PAGE>
certain payments, including cash dividends, by the Company on its Common Stock.
See "Price Range of Common Stock and Dividend Policy" and "Description of
Certain Indebtedness--New Credit Facility" and "--the Notes."
SHARES ELIGIBLE FOR FUTURE SALE
After the Common Stock Offering and including the 904,646 shares of Common
Stock issued in the KUI Acquisition, a total of 20,142,560 shares of Common
Stock (20,817,560 shares, if the over-allotment options are exercised in full)
will be outstanding. In addition, 2,178,191 shares of Common Stock are issuable
upon the exercise of outstanding stock options pursuant to the Amended and
Restated 1987 Incentive Stock Option Plan, the Directors Nonqualified Stock
Option Plan and the 1993 Executive Stock Option Plan (the "Plans"). Of these
shares, the Company has registered 1,751,611 shares under the Securities Act.
The Company has also granted certain registration rights to certain investors
covering an aggregate of 5,752,587 shares. See "Shares Eligible For Future
Sale." The Company, its executive officers and directors and Zell/Chilmark Fund
L.P. ("Zell Chilmark") have agreed that, for a period of 90 days after the date
hereof, they will not sell or otherwise dispose of any shares of Common Stock
without the prior written consent of Merrill Lynch, Pierce, Fenner & Smith
Incorporated, in each case subject to certain limited exceptions. However, no
prediction can be made as to the effect, if any, that future sales of shares, or
the availability of shares for future sale, will have on the market price of the
Common Stock prevailing from time to time. Sales of substantial amounts of
Common Stock in the public market, or the perception that such sales could
occur, could adversely affect prevailing market prices for the Common Stock and
could impair the Company's ability to raise capital through an offering of its
equity securities. See "Underwriting."
RISKS RELATING TO SANTEE DAIRIES
Hughes and Stater each own a 50% interest in Santee, which operates one of
the largest dairy plants in Southern California. In order to provide a
consistent source of milk, to accommodate expected expansion at both Hughes and
Stater, and in order to contain costs, Santee has begun construction of a new
dairy plant at an estimated total cost of approximately $100 million (including
production equipment and capitalized interest and other costs) and negotiations
are currently under way with certain parties to provide Santee with
approximately $80 million of long-term financing to fund construction costs. As
of the date hereof, the prospective lenders have orally agreed in principle to
certain primary terms of such long-term financing, including the applicable
interest rate. See "Description of Certain Indebtedness--Santee Dairies."
However, there can be no assurance that Santee will be able to obtain this
long-term financing on acceptable terms, or at all, and any failure to obtain
such financing could delay construction of the dairy and could have a material
adverse effect on the Company. In that regard, both Hughes and Stater may be
requested to provide credit support for any long-term financing which Santee may
arrange or otherwise enter into agreements or arrangements intended to assure
repayment of such indebtedness. Moreover, because the terms of the proposed
long-term financing have not been finalized, there can be no assurance that the
actual terms of any such financing will not differ materially from those
described herein. As a result, investors will be subject to risks and
uncertainties relating to such financing, including a risk that the definitive
terms thereof may be materially more burdensome to the Company or Santee than
those described herein.
Although it is estimated that, as of January 31, 1997, approximately 40% of
the aggregate budgeted capital expenditures for the construction of the new
dairy had been made, there can be no assurance that the new dairy can be
completed in a timely manner or for the amount currently budgeted, that Santee
will not experience delays or difficulties in the completion of construction of
or the commencement of operations at the new dairy, or that the new dairy will
perform in accordance with expectations. However, pursuant to the terms of the
construction contract for the new dairy, the contractor and the subcontractors
have warranted that for a period of two years they will correct, at their own
expense, any work which
S-23
<PAGE>
proves to be defective in workmanship and materials. Any equipment incorporated
into the new dairy at Santee's request is covered exclusively by the warranties
of the manufacturers. Further, a surety company has posted a performance bond
pursuant to which it has assumed the risk of delivering a plant meeting the
contracted specifications. If, however, construction is delayed past April 1998
and Santee is required to remain a tenant at its existing dairy plant, Santee
will become subject to an additional $164,000 per month in rent. Under the terms
of the existing lease, Santee can request an extension of an additional five
months, after which time the lease will terminate. Any termination of the lease
at the existing dairy plant before the new plant is operational would require
that the Company seek other suppliers of milk and similar products for its
Hughes stores and could therefore have a material adverse effect on the Company.
In addition, pursuant to an agreement with the City of Industry
Urban-Development Agency in connection with the construction of the new dairy
plant, Santee must complete construction of the new dairy plant by April 30,
1998 at a total value of at least $65 million. In the event the new dairy plant
is not completed by such date, Santee will become obligated to pay real property
taxes based on the difference between the value of the dairy at April 30, 1998
and $65 million until the dairy is completed, or for a maximum of ten years.
In addition, over the past four years, Santee's operations have generated
net losses of approximately $6 million in the aggregate, primarily as a result
of increased rent expense resulting from the expected early termination of the
existing dairy lease and the accelerated depreciation of its leasehold interest
and equipment at the existing dairy. Although it is believed that the new dairy,
when fully operational, will lower Santee's costs of producing fluid milk and
other products, there can be no assurance that this will occur or that these
losses will not continue.
Santee is party to the Santee Credit Facilities (as defined herein), is
currently in default under certain of the financial covenants relating thereto,
and is presently negotiating with its lender to extend the Santee Credit
Facilities and to obtain appropriate waivers. Notwithstanding such default, its
lender has allowed Santee to continue to borrow under the Santee Revolver (as
defined herein) without a formal waiver. It is expected that all the Santee
Credit Facilities will remain in place after the Hughes Acquisition except for
the Santee Bridge Loan (as defined herein) which is expected to be replaced by
long-term dairy financing, if and when obtained by Santee. See "Description of
Certain Indebtedness--Santee Dairies." There can be no assurance that Santee
will be able to comply with the covenants and other restrictions in its debt
instruments in the future (including, without limitation, those imposed by any
long-term dairy financing), and a default under those instruments generally
would permit the lenders to accelerate the indebtedness thereunder and to
proceed against any collateral pledged as security for that indebtedness, which
could have a material adverse effect on the Company, particularly if the Company
has provided credit support or entered into other agreements or arrangments
intended to assure the repayment of Santee's indebtedness. It is contemplated
that any long-term financing obtained by Santee will be secured by certain of
its assets, including real property, equipment and machinery, and will also be
secured by the capital stock of Santee which is owned by Hughes and Stater.
Hughes currently purchases substantially all of the fluid milk sold in its
supermarkets from Santee. If the supply of milk from Santee were to be
interrupted for a short period of time because of difficulties relating to the
new dairy currently under construction or otherwise, then Hughes may be able to
purchase milk for its stores from other suppliers, although at higher prices.
However, because there would be a lack of a consistent source of supply, any
long-term disruption could have a material adverse effect on the Company's
results of operations. Pursuant to the anticipated terms of product purchase
agreements expected to be entered into with Santee (the "Product Purchase
Agreements"), each of Hughes and Stater will be obligated to purchase all of its
fluid milk and other specified Santee-produced product requirements from Santee,
subject to certain exceptions. However, as of the date hereof, no Product
Purchase Agreements had been executed. Although such purchases are currently
being made at below market prices, it is expected that the terms of the
long-term financing for the new dairy will require that each of Hughes and
Stater will be required to pay increased prices to the extent necessary to
maintain Santee's debt service coverage ratio and fixed charge coverage ratio
above specified levels. As a result, there can be
S-24
<PAGE>
no assurance that the prices paid by Hughes to Santee will not increase, perhaps
substantially, which could have a material adverse effect on the Company. In
calendar 1996, Stater purchased more than twice as much fluid milk from Santee
than did Hughes. See "Description of Certain Indebtedness--Santee Dairies."
As set forth under "Description of Certain Indebtedness--Santee Dairies," it
is expected that (i) the Santee Notes and/or the Product Purchase Agreements
will contain provisions requiring that a specified interest and rental expense
coverage ratio of the Company (or, if the proposed Reorganization is
consummated, Parent) be maintained, and that each of Hughes and Stater maintain
a specified consolidated net worth and a specified fixed charge coverage ratio
and (ii) the Santee Notes will contain customary events of default, including
events of default triggered by the acceleration of debt of Holding Company and
its consolidated subsidiaries aggregating $15 million, the acceleration of debt
of Stater aggregating $10 million, a default by Hughes in respect of its
indebtedness (excluding guarantees of indebtedness of Holding Company and its
consolidated subsidiaries) aggregating $7.5 million, and a default under certain
provisions of the Product Purchase Agreements. If Stater were to so default, or
if indebtedness of Stater in such amount were to be accelerated, such
noncompliance or acceleration could result in increased prices for products
and/or in the acceleration of the Santee Notes. As a result, such increased
prices and/or acceleration may be triggered by events relating to Stater over
which Hughes and Santee have no control and could have a material adverse effect
on the Company.
The ability of Santee to meet its debt service and other obligations will
require, among other things, the continued purchase of milk and other products
by Stater. The failure by Stater to fully perform its obligations to Santee
(including its obligations to purchase products and maintain compliance with
various financial and other covenants) could, among other things, require that
the Company provide funds to Santee to cover any shortfall, which could have a
material adverse effect on the Company. Moreover, there can be no assurance that
the Company would be able to provide funds to cover any such shortfall which
could result in a default under any long-term dairy financing which would
generally entitle the lenders thereunder to accelerate such indebtedness and to
foreclose upon the collateral for such indebtedness.
CHANGE IN STATE OF INCORPORATION FOLLOWING THE PROPOSED REORGANIZATION
QFC is a Washington corporation. If the proposed Reorganization occurs as
planned, holders of the Company's Common Stock (including investors purchasing
shares in the Common Stock Offering) will generally become holders of common
stock of Parent, which is a Delaware corporation. Accordingly, if the proposed
Reorganization occurs, matters relating to stockholders' rights, corporate
governance and similar matters generally will be governed by Delaware law rather
than Washington law, and no assurance can be given that Delaware law with
respect to these matters will not be less favorable to shareholders than
Washington law.
S-25
<PAGE>
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The Common Stock of QFC is traded on the New York Stock Exchange under the
symbol "XQ." Prior to February 20, 1997, the Common Stock of QFC was traded on
The Nasdaq National Market. Presented below are quarterly high and low last
reported sale prices for QFC's Common Stock on The Nasdaq National Market
through February 19, 1997 and, thereafter, on the New York Stock Exchange. The
quotations from The Nasdaq National Market reflect inter-dealer prices, without
retail mark-up, mark-down or commission and may not necessarily reflect actual
transactions.
<TABLE>
<CAPTION>
HIGH LOW
--------- -------
<S> <C> <C> <C>
FISCAL 1994
First Quarter............................................................... $ 25 1/4 $ 21 3/4
Second Quarter.............................................................. 24 19 1/2
Third Quarter............................................................... 24 3/4 21 1/2
Fourth Quarter.............................................................. 24 1/4 19
FISCAL 1995
First Quarter............................................................... $ 24 1/2 $ 21 1/4
Second Quarter.............................................................. 22 1/4 19
Third Quarter............................................................... 26 3/4 19 1/2
Fourth Quarter.............................................................. 22 1/2 19 1/2
FISCAL 1996
First Quarter............................................................... $ 23 1/4 $ 20 1/4
Second Quarter.............................................................. 29 1/4 22 1/4
Third Quarter............................................................... 31 1/2 25 1/2
Fourth Quarter.............................................................. 39 1/2 30 1/16
FISCAL 1997
First Quarter (through March 13, 1997)...................................... $ 42 1/4 $ 33 3/4
</TABLE>
QFC had approximately 2,660 shareholders of record as of January 31, 1997.
The Company currently does not pay cash dividends on its Common Stock and
presently intends to retain available funds to finance the growth and operations
of its business. Subject to certain exceptions, the New Credit Facility will
restrict the payment of cash dividends on the Common Stock, and the Indenture to
be entered into in connection with the Notes Offering will also restrict the
making of certain payments, including cash dividends, by the Company on its
Common Stock. See "Description of Certain Indebtedness." In February 1995, QFC
paid a cash dividend of $.05 per share, or an aggregate of $1.0 million, to its
shareholders, but subsequently discontinued the payment of dividends as the
result of prohibitions set forth in the Current Credit Facility. During 1994,
QFC paid quarterly cash dividends of $.05 per share for an annual rate of $.20
per share, or an aggregate of $3.9 million for the year.
S-26
<PAGE>
THE ACQUISITIONS
The statements made under this heading relating to the Hughes Acquisition
are summaries of the agreements described herein, do not purport to be complete
and are qualified in their entirety by reference to such agreements.
HUGHES MARKETS, INC.
HUGHES MERGER AGREEMENT. QFC, QHI Acquisition Corporation ("QHI"), a
California corporation and as of the date hereof, a wholly-owned subsidiary of
QFC, and Hughes Markets, Inc. ("Hughes"), a California corporation, entered into
an Agreement and Plan of Merger, dated as of November 20, 1996 (the "Hughes
Merger Agreement"), pursuant to which QHI will be merged with and into Hughes
(the "Hughes Acquisition"), with Hughes continuing as the surviving corporation.
The aggregate consideration to be paid for all outstanding shares of common
stock of Hughes will be approximately $358.8 million (the "Hughes Purchase
Price") and will be subject to increase for each week that the Hughes
Acquisition is delayed past a certain deadline because of a delay in obtaining
the financing for the Hughes Acquisition, subject to certain exceptions. In lieu
of calling and convening a meeting of its shareholders, Hughes has obtained the
written consent of the requisite majority of its shareholders for approval of
the Hughes Merger Agreement and the transactions contemplated thereby.
The respective obligations of QFC and Hughes to effect the Hughes
Acquisition are subject to the satisfaction of certain conditions, including but
not limited to (a) the termination or expiration of the relevant waiting period
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the
"HSR Act"), and (b) the absence of any judicial order or legal restraint
preventing the consummation of the Hughes Acquisition. The obligations of QFC to
effect the Hughes Acquisition are further conditioned on, among others: (i) the
execution and delivery in a form reasonably satisfactory to QFC of all material
agreements, and all revisions, amendments and modifications thereto, relating to
the construction by Santee, currently a 50% owned affiliate of Hughes, of a new
dairy plant (such agreements, as revised, amended or otherwise modified, the
"Santee Agreements"); (ii) the total capital cost of constructing Santee's new
plant not exceeding specified limits; and (iii) there not having occurred and be
continuing for at least ten consecutive trading days (x) a decline of 20% or
more in the Dow Jones Average of Industrial Stocks from the November 20, 1996
closing level, (y) an increase of the yield on the ten year U.S. Treasury notes
to 8.50% per annum or higher or (z) a similar material disruption in the capital
markets which makes it impracticable for QFC to obtain the necessary financing
for the Hughes Acquisition. Except to the extent set forth above in clause
(iii), QFC's obligations to consummate the Hughes Acquisition pursuant to the
Hughes Merger Agreement are not conditioned upon its ability to raise sufficient
funds to do so. The waiting period under the HSR Act expired on January 30,
1997. Because the Hughes Acquisition will close prior to the execution of
documentation relating to any long-term financing to fund construction costs for
the new dairy plant, QFC will effectively be waiving the conditions described in
clauses (i) and (ii) above.
The Hughes Merger Agreement contains customary representations, warranties
and covenants and provides for termination prior to closing under certain
circumstances. If the Hughes Merger Agreement is terminated (i) by mutual
consent of the parties, (ii) by either QFC or Hughes because the shareholders of
Hughes have not approved the Hughes Acquisition, or (iii) by QFC because (x) the
Board of Directors of Hughes withdraws its recommendation of the Hughes
Acquisition or recommends the acquisition of control of Hughes by a party other
than QFC or any of its subsidiaries (such party, a "Third Party" and such
acquisition, a "Third Party Acquisition"), (y) a Third Party acquires more than
25% of the common stock of Hughes or (z) any of the Principal Shareholders (as
defined below) breaches any representation, warranty or covenant in the
Principal Shareholders Agreement (as defined below), and within 12 months Hughes
effects a Third Party Acquisition, then Hughes will pay to QFC a fee in the
amount of $7.2 million.
S-27
<PAGE>
PRINCIPAL SHAREHOLDERS AGREEMENT. Pursuant to the agreement, dated as of
November 20, 1996, by and among QFC and certain shareholders of Hughes who hold
approximately 91% of the common stock of Hughes (such shareholders, the
"Principal Shareholders"; such agreement, the "Principal Shareholders
Agreement"), the Principal Shareholders have agreed, among other things, (i) to
give their written consent to the Hughes Acquisition, to the execution and
delivery by Hughes of the Hughes Merger Agreement and the approval of the terms
thereof and to each of the other actions contemplated thereby and by the
Principal Shareholders Agreement; (ii) to vote all of their shares in favor of
the Hughes Merger Agreement and the transactions contemplated thereby at any
meeting of shareholders; and (iii) not to enter into any agreement to vote or to
give their written consent or any instructions inconsistent with clauses (i) or
(ii). The written consents of all Principal Shareholders approving the Hughes
Merger Agreement and the transactions contemplated thereby were delivered to QFC
on November 25, 1996.
SANTEE DAIRIES. Hughes and Stater are co-owners of Santee, which operates
one of the largest dairy plants in California. Prior to November 1996, Santee
was a 51%-owned subsidiary of Hughes, and the accounts of Santee were included
in the consolidated financial statements of Hughes. In November 1996, Hughes
sold a 1% interest in Santee to Stater (which previously owned 49% of Santee),
resulting in (i) Hughes and Stater each becoming 50% owners of Santee and (ii)
Santee ceasing to be a consolidated subsidiary of Hughes. See "Unaudited Pro
Forma Condensed Consolidated Financial Statements," "Risk Factors--Risks
Relating to Santee Dairies," "Business--Hughes Markets, Inc.--Santee Dairies"
and "Description of Certain Indebtedness--Santee Dairies."
KEITH UDDENBERG, INC.
On February 14, 1997, QFC acquired Keith Uddenberg, Inc. for approximately
$35.3 million in cash and 904,646 shares of Common Stock. The cash portion of
the purchase price was financed, and approximately $24.3 million of
then-existing KUI indebtedness was refinanced, with borrowings under QFC's
Current Credit Facility. Prior to the KUI Acquisition, Keith Uddenberg, Inc.
distributed to its shareholders, in a "spin-off" transaction, certain property,
including assets and liabilities unrelated to its grocery store business, real
estate owned by it and one grocery store. In addition, at the time of the KUI
Acquisition QFC entered into an Investors Rights Agreement granting to the
former KUI shareholders certain demand and piggyback registration rights. See
"Shares Eligible For Future Sale."
FINANCING
The Company will require approximately $570.3 million in cash to: (i)
finance the Hughes Acquisition, (ii) refinance QFC's bank indebtedness
(including the $59.6 million of indebtedness incurred in connection with the KUI
Acquisition) and (iii) pay fees and expenses. Such funds are expected to be
provided by: (i) the proceeds from the Common Stock Offering, (ii) the proceeds
from the Notes Offering and (iii) borrowings by the Company under an amended and
restated $250 million term loan facility (the "Term Loan Facility"). The Company
will also receive an additional $5.2 million which will be used for general
corporate purposes. See "Use of Proceeds" and "Description of Certain
Indebtedness."
S-28
<PAGE>
The following table sets forth the sources and uses of funds in connection
with the transactions described above.
<TABLE>
<CAPTION>
AMOUNT
-------------------
(DOLLARS IN
MILLIONS)
<S> <C>
SOURCES:
The Common Stock Offering(1)............................................ $ 175.5
The Notes Offering(2)................................................... 150.0
Term Loan Facility...................................................... 250.0
-------
Total Sources......................................................... $ 575.5
-------
-------
USES:
Hughes purchase price................................................... $ 358.8
Refinancing of QFC bank debt(3)......................................... 197.0
Estimated fees and expenses............................................. 14.5
General corporate purposes.............................................. 5.2
-------
Total Uses............................................................ $ 575.5
-------
-------
</TABLE>
- ------------------------
(1) Represents gross proceeds from the Common Stock Offering.
(2) Represents gross proceeds from the Notes Offering.
(3) Includes $59.6 million of indebtedness incurred under the Current Credit
Facility to pay the $35.3 million cash portion of the KUI purchase price and
to refinance $24.3 million of previously existing KUI indebtedness.
S-29
<PAGE>
THE PROPOSED REORGANIZATION
Following consummation of the Hughes Acquisition, the Company intends to
seek shareholder approval to change its corporate structure (the
"Reorganization"). Subject to obtaining such shareholder approval, upon
consummation of the Reorganization, KUI will remain a subsidiary of QFC, and
each of QFC and Hughes will become a subsidiary of Quality Food Holdings, Inc.,
a Delaware corporation ("Holding Company"), which in turn will be a subsidiary
of Quality Food, Inc., a Delaware corporation ("Parent"), and the current
shareholders of QFC will thereupon generally become shareholders of Parent.
Parent and Holding Company are both currently subsidiaries of QFC.
The Reorganization is intended to facilitate the Company's strategy of
becoming a leading multi-regional operator of premium supermarkets. In order to
facilitate this phase of the Company's development, the Company has hired a new
chief executive officer, Christopher A. Sinclair, to pursue and integrate
acquisitions at a holding company level, thus allowing current senior management
to remain focused on existing operations. If the Reorganization is consummated,
Mr. Sinclair will be the chief executive officer of Parent and Holding Company,
while Dan Kourkoumelis will remain chief executive officer at QFC in charge of
the Company's Seattle/Puget Sound operations. Mr. Sinclair will be assisted by a
new senior vice president for corporate development. Roger Hughes will remain
chief executive officer at Hughes. See "Management."
The following charts depict the organizational structure of the Company: (i)
at closing of the Hughes Acquisition and the Financings and (ii) immediately
following the proposed Reorganization.
[LOGO]
S-30
<PAGE>
[LOGO]
S-31
<PAGE>
USE OF PROCEEDS
The Company intends to use: (i) all of the $175.5 million of gross proceeds
from the Common Stock Offering (approximately $202 million if the overallotment
options are exercised in full), (ii) all of the $150 million of gross proceeds
from the Notes Offering and (iii) $250 million of borrowings under the Term Loan
Facility to pay the $358.8 million Hughes purchase price, to refinance an
estimated $197 million of QFC bank indebtedness which is anticipated to be
outstanding at the time of the Closing (including $59.6 million of indebtedness
incurred in connection with the KUI Acquisition) and to pay an estimated $14.5
million in fees and expenses. The remaining $5.2 million will be used for
general corporate purposes.
Amounts presently outstanding under the Current Credit Facility accrue
interest at a rate of LIBOR plus 1.25% per annum. The approximately $24.3
million of previously existing debt at KUI, which was refinanced with the
proceeds of borrowings under the Current Credit Facility and which will be
refinanced at the Closing with borrowings under the Term Loan Facility, accrued
interest at a weighted average rate of 7.26% per annum.
S-32
<PAGE>
CAPITALIZATION
The following table sets forth (i) the historical cash and cash equivalents
and capitalization of QFC at September 7, 1996 and (ii) the pro forma cash and
cash equivalents and pro forma capitalization of the Company and its
consolidated subsidiaries at September 7, 1996, after giving pro forma effect to
the Acquisitions and the Financings and the application of the estimated net
proceeds therefrom as described under "Use of Proceeds." The following pro forma
data do not purport to be indicative of the actual cash and cash equivalents or
capitalization that would have occurred had the transactions and events
reflected therein in fact occurred on the dates specified. This table should be
read in conjunction with "Unaudited Pro Forma Condensed Consolidated Financial
Statements" and the notes thereto, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the historical financial
statements of QFC, Hughes and KUI and related notes thereto included or
incorporated by reference herein.
<TABLE>
<CAPTION>
AT SEPTEMBER 7, 1996
-----------------------
<S> <C> <C>
ACTUAL PRO FORMA
---------- -----------
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Cash and Cash Equivalents............................................ $ 11,570 $ 16,404
---------- -----------
---------- -----------
Total Debt (including current portion):
Revolving Credit Facility.......................................... $ 10,000 $ -- (1)
Term Loan Facility................................................. 140,000 250,000
Senior Subordinated Notes due 2007................................. -- 150,000
Other Debt......................................................... -- 32,731(2)
---------- -----------
Total Debt....................................................... 150,000 432,731(3)
Shareholders' Equity:
Common Stock, $.001 par value, at stated value-- 60,000,000 shares
authorized; 14,579,000 shares issued and outstanding; 19,983,646
shares issued and outstanding pro forma(3)....................... 31,176 234,330
Retained Earnings.................................................. 33,231 33,231
---------- -----------
Total Shareholders' Equity....................................... 64,407 267,561
---------- -----------
Total Capitalization................................................. $ 214,407 $ 700,292
---------- -----------
---------- -----------
</TABLE>
- ------------------------
(1) On a pro forma basis, the Company would have had $125 million of
availability under an amended and restated $125 million revolving credit
facility (the "Revolving Credit Facility") (less amounts allocated to
letters of credit) and $225 million of availability under the Acquisition
Facility. See "Description of Certain Indebtedness--New Credit Facility."
(2) Represents $25.5 million of capitalized leases and $7.2 million of other
indebtedness which will be acquired in connection with the Hughes
Acquisition.
(3) Pro forma data includes the 904,646 shares issued in the KUI Acquisition and
the issuance of 4,500,000 shares of Common Stock in the Common Stock
Offering and excludes shares issuable upon the exercise of outstanding stock
options. See "Shares Eligible For Future Sale."
S-33
<PAGE>
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The following unaudited pro forma condensed consolidated financial
statements (the "Pro Forma Financial Statements") are based on historical
financial statements of QFC, Hughes, and KUI and have been prepared to
illustrate the effects of the Acquisitions and other related transactions
described below and the assumed financing therefor.
The unaudited pro forma condensed consolidated statement of earnings for the
year ended December 30, 1995 gives effect to each of the following transactions
as if such transactions had been completed as of January 1, 1995: (i) the Hughes
Acquisition and certain related transactions; (ii) Hughes' sale to Stater in
November 1996 of a 1% equity interest in Santee, which, prior to that sale, was
a 51%-owned subsidiary of Hughes, resulting in Santee ceasing to be a
consolidated subsidiary of Hughes; (iii) KUI's spin off of certain assets and
liabilities, primarily related to non-grocery operations, prior to the KUI
Acquisition; (iv) the KUI Acquisition and certain related transactions; (v) the
application of the estimated net proceeds from the Common Stock Offering and the
Notes Offering (the "Offerings") and borrowings under the New Credit Facility to
finance the Hughes Acquisition and to refinance bank debt of QFC expected to be
outstanding at the time of the Closing (including indebtedness which was
incurred in connection with the KUI Acquisition); and (vi) QFC's proposed
divestiture of five recently acquired KUI stores. The unaudited pro forma
condensed consolidated statement of earnings for the 36 weeks ended September 7,
1996 gives effect to the transactions described above as if such transactions
had been completed as of December 31, 1995. The unaudited pro forma condensed
consolidated statement of earnings for the 52 weeks ended September 7, 1996
gives effect to the transactions described above as if such transactions had
been completed as of September 10, 1995. The unaudited pro forma condensed
consolidated balance sheet as of September 7, 1996 gives effect to the
transactions described above as if such transactions had been completed as of
that date. The effect of the proposed divestiture of five recently acquired KUI
stores is reflected in the pro forma balance sheet as assets held for sale.
The Hughes Acquisition and KUI Acquisition will be accounted for using the
purchase method of accounting. The total purchase price of each of the
Acquisitions will be allocated to the tangible and intangible assets and
liabilities acquired based upon their respective fair values. The allocation of
each of the aggregate purchase prices reflected in the Pro Forma Financial
Statements is preliminary and is subject to adjustment, upon the receipt of,
among other things, certain appraisals of the acquired assets and liabilities.
The Pro Forma Financial Statements do not purport to present the actual
financial position or results of operations that would have occurred had the
transactions and events reflected therein in fact occurred on the dates
specified, nor do they purport to be indicative of the results of operations or
financial condition that may be achieved in the future. The Company anticipates
that the Acquisitions will result in certain synergies and economies of scale
resulting from, among other things, reduction in administrative costs and
enhanced buying power. However, none of these anticipated benefits is reflected
in the Pro Forma Financial Statements and there can be no assurance that they
will be realized. The Pro Forma Financial Statements are based on certain
assumptions and adjustments described in the notes hereto and should be read in
conjunction therewith.
In addition, the pro forma condensed consolidated statements of earnings
reflect QFC's proposed divestiture of five of the stores recently acquired in
the KUI Acquisition. QFC believes, based upon past experience in selling stores,
that it will be able to dispose of these stores, although it has not entered
into any definitive agreements for that purpose. Accordingly, there can be no
assurance as to the actual sales proceeds which may be received by the Company
therefor or when those stores may be sold. In addition, QFC anticipates that it
will make capital expenditures of approximately $22 million through 1998 in
order to convert certain KUI stores, expected to be retained following the KUI
Acquisition, to the QFC format; such capital expenditures are not reflected in
the Pro Forma Financial Statements.
S-34
<PAGE>
The Pro Forma Financial Statements should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included herein, the historical financial statements and notes
thereto of QFC, the historical consolidated financial statements and notes
thereto of Hughes, and the historical financial statements and notes thereto of
KUI, all of which are included or incorporated by reference herein.
S-35
<PAGE>
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
AS OF SEPTEMBER 7, 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
HISTORICAL HISTORICAL HISTORICAL
QFC HUGHES HUGHES PRO KUI
SEPTEMBER 7, SEPTEMBER 29, FORMA HUGHES SEPTEMBER 28,
1996(A) 1996(A) ADJUSTMENTS(B) PRO FORMA 1996(A)
------------ ------------- -------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
ASSETS
Current assets:
Cash & cash equivalents..................... $ 11,570 $ 10,454 $ (19) $ 10,435 $ 1,865
Accounts receivable......................... 9,655 18,175 (10,437) 7,738 5,190
Inventories................................. 35,670 53,966 (4,290) 49,676 11,523
Prepaid expenses............................ 6,442 9,291 (1,727) 7,564 281
------------ ------------- -------------- ----------- -------------
TOTAL CURRENT ASSETS.................... 63,337 91,886 (16,473) 75,413 18,859
Investment in subsidiary.................... 8,649 8,649
Properties
Land........................................ 15,025 43,913 (6,392) 37,521 2,415
Buildings, fixtures and equipment........... 152,331 221,182 (32,976) 188,206 50,728
Leasehold improvements...................... 43,084 48,385 48,385 2,576
Construction in progress.................... 6,927 11,871 (11,871) 4,017
------------ ------------- -------------- ----------- -------------
217,367 325,351 (51,239) 274,112 59,736
Accumulated depreciation and amortization... (59,878) (131,478) 24,597 (106,881) (29,531)
------------ ------------- -------------- ----------- -------------
157,489 193,873 (26,642) 167,231 30,205
Property under capital leases............... 19,500 19,500
Assets held for sale........................
Leasehold interest.......................... 27,382 4,946 (464) 4,482
Real estate held for investment............. 5,888 865
Goodwill.................................... 33,857
Other assets................................ 5,657 5,504 (438) 5,066 7,248
------------ ------------- -------------- ----------- -------------
TOTAL ASSETS............................ $ 293,610 $ 315,709 $ (35,368) $ 280,341 $ 57,177
------------ ------------- -------------- ----------- -------------
------------ ------------- -------------- ----------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable............................ $ 33,414 $ 53,678 $ (12,694) $ 40,984 $ 14,496
Accrued liabilities......................... 27,926 39,893 (5,716) 34,177 4,893
Current portion long term debt.............. 18,900 9,204 (5,000) 4,204 2,662
Current portion capital lease obligation.... 559 559
------------ ------------- -------------- ----------- -------------
TOTAL CURRENT LIABILITIES............... 80,240 103,334 (23,410) 79,924 22,051
Deferred income taxes....................... 11,735 8,644 (169) 8,475
Other liabilities........................... 6,128 6,623 (3,420) 3,203 4,168
Long term debt.............................. 131,100 3,044 3,044 23,621
Capital lease obligation.................... 24,924 24,924
Preferred stock dividend.................... 3,328
Minority interest........................... 8,369 (8,369)
Shareholders' equity........................ 64,407 160,771 160,771 4,009
------------ ------------- -------------- ----------- -------------
TOTAL LIABILITIES & SHAREHOLDERS'
EQUITY................................ $ 293,610 $ 315,709 $ (35,368) $ 280,341 $ 57,177
------------ ------------- -------------- ----------- -------------
------------ ------------- -------------- ----------- -------------
<CAPTION>
PRO FORMA
ADJUSTMENTS FOR QFC/HUGHES/KUI
KUI ACQUISITIONS CONSOLIDATED
PRO FORMA KUI AND PRO FORMA
ADJUSTMENTS(C) PRO FORMA OFFERINGS(D) (AS ADJUSTED)
--------------- ----------- --------------- ----------------
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash & cash equivalents..................... $ -- $ 1,865 $ (7,466)(d) $ 16,404
Accounts receivable......................... (150) 5,040 22,433
Inventories................................. (2,060) 9,463 23,866(h) 115,175
(3,500)(m)
Prepaid expenses............................ (7) 274 14,280
------- ----------- --------------- ----------------
TOTAL CURRENT ASSETS.................... (2,217) 16,642 12,900 168,292
Investment in subsidiary.................... (2,500)(n) 6,149
Properties
Land........................................ (675) 1,740 3,000(i) 57,286
Buildings, fixtures and equipment........... (3,361) 47,367 20,000(i) 401,804
(6,100)(m)
Leasehold improvements...................... (155) 2,421 93,890
Construction in progress.................... 4,017 10,944
------- ----------- --------------- ----------------
(4,191) 55,545 16,900 563,924
Accumulated depreciation and amortization... 2,129 (27,402) (194,161)
------- ----------- --------------- ----------------
(2,062) 28,143 16,900 369,763
Property under capital leases............... 19,500
Assets held for sale........................ 9,600(m) 9,600
Leasehold interest.......................... 75,000(j) 106,864
Real estate held for investment............. (865) 5,888
Goodwill.................................... 136,625(k) 172,982
2,500(n)
Other assets................................ (183) 7,065 5,930(l) 29,912
6,194(d)
------- ----------- --------------- ----------------
TOTAL ASSETS............................ $ (5,327) $ 51,850 $ 263,149 $ 888,950
------- ----------- --------------- ----------------
------- ----------- --------------- ----------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable............................ $ (917) $ 13,579 $ -- $ 87,977
Accrued liabilities......................... (24) 4,869 66,972
Current portion long term debt.............. 2,662 (21,562)(d) 4,204
Current portion capital lease obligation.... 559
------- ----------- --------------- ----------------
TOTAL CURRENT LIABILITIES............... (941) 21,110 (21,562) 159,712
Deferred income taxes....................... 20,210
Other liabilities........................... 4,168 13,499
Long term debt.............................. (2,000) 21,621 247,279(d) 403,044
Capital lease obligation.................... 24,924
Preferred stock dividend.................... (3,328)
Minority interest...........................
Shareholders' equity........................ 942 4,951 (165,722)(g) 267,561
167,194(e)
35,960(f)
------- ----------- --------------- ----------------
TOTAL LIABILITIES & SHAREHOLDERS'
EQUITY................................ $ (5,327) $ 51,850 $ 263,149 $ 888,950
------- ----------- --------------- ----------------
------- ----------- --------------- ----------------
</TABLE>
S-36
<PAGE>
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT
OF EARNINGS FOR THE FISCAL YEAR ENDED DECEMBER 30, 1995
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
<TABLE>
<CAPTION>
HISTORICAL
HISTORICAL QFC HUGHES HISTORICAL KUI
FISCAL YEAR FISCAL YEAR FISCAL YEAR
ENDED ENDED HUGHES ENDED
DECEMBER 30, MARCH 3, PRO FORMA HUGHES PRO DECEMBER 30,
1995(A) 1996(A) ADJUSTMENTS(B) FORMA 1995(A)
---------------- ---------------- -------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
Sales................................. $ 729,856 $1,147,447 $ (161,678) $ 985,769 $ 319,141
Cost of sales and related occupancy
expenses............................ 550,434 901,951 (139,446) 762,505 250,823
Marketing, general, and administrative
expenses............................ 136,644 215,234 (24,008) 191,226 70,441
---------------- ---------------- -------------- ----------- ----------------
Operating income (loss)............... 42,778 30,262 1,776 32,038 (2,123)
Interest income....................... 501 1,272 (602) 670 79
Interest expense...................... (9,639) (4,335) 50 (4,285) (1,939)
Other income (expense)................ (1,400)(r) 2,066
---------------- ---------------- -------------- ----------- ----------------
Earnings before income taxes.......... 32,240 27,199 1,224 28,423 (1,917)
Total taxes on income................. 12,023 11,382 471 11,853 (674)
---------------- ---------------- -------------- ----------- ----------------
Income before minority interest....... 20,217 15,817 753 16,570 (1,243)
---------------- ---------------- -------------- ----------- ----------------
Equity losses......................... (384) (384)
Minority interest in subsidiary
loss................................ 369 (369)
---------------- ---------------- -------------- ----------- ----------------
Net earnings (loss)................... $ 20,217 $ 16,186 $ -- $ 16,186 $ (1,243)
---------------- ---------------- -------------- ----------- ----------------
---------------- ---------------- -------------- ----------- ----------------
Earnings per share(t)................. $ 1.28
Weighted average shares outstanding... 15,830
EBITDA (s)............................ $ 59,567 $ 42,439 $ (1,076) $ 41,363 $ 3,409
<CAPTION>
PRO FORMA
ADJUSTMENTS FOR QFC/HUGHES/KUI
ACQUISITIONS CONSOLIDATED
KUI PRO FORMA KUI AND PRO FORMA
ADJUSTMENTS(C) PRO FORMA OFFERINGS(D) (AS ADJUSTED)
-------------- ----------- --------------- ----------------
<S> <C> <C> <C> <C>
Sales................................. $ (12,761) $ 306,380 $ (36,287)(m) $ 1,985,718
Cost of sales and related occupancy
expenses............................ (11,405) 239,418 (29,936)(m) 1,522,421
Marketing, general, and administrative
expenses............................ (2,793) 67,648 (9,379)(m) 393,451
7,312(o)
-------------- ----------- --------------- ----------------
Operating income (loss)............... 1,437 (686) (4,284) 69,846
Interest income....................... 79 1,250
Interest expense...................... (1,939) (18,937)(p) (34,800)
Other income (expense)................ (522) 1,544 144
-------------- ----------- --------------- ----------------
Earnings before income taxes.......... 915 (1,002) (23,221) 36,440
Total taxes on income................. 311 (363) (6,045)(q) 17,468
-------------- ----------- --------------- ----------------
Income before minority interest....... 604 (639) (17,176) 18,972
-------------- ----------- --------------- ----------------
Equity losses......................... (384)
Minority interest in subsidiary
loss................................
-------------- ----------- --------------- ----------------
Net earnings (loss)................... $ 604 $ (639) $ (17,176) $ 18,588
-------------- ----------- --------------- ----------------
-------------- ----------- --------------- ----------------
Earnings per share(t)................. $ 0.88
Weighted average shares outstanding... 5,405 (e)(f 21,235
EBITDA (s)............................ $ 706 $ 4,115 $ 2,408 $ 107,453
</TABLE>
S-37
<PAGE>
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT
OF EARNINGS FOR THE 36 WEEKS ENDED SEPTEMBER 7, 1996
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
<TABLE>
<CAPTION>
HISTORICAL HISTORICAL HISTORICAL
QFC HUGHES KUI
36 WEEKS ENDED 9 MONTHS ENDED HUGHES 39 WEEKS ENDED
SEPTEMBER 7, SEPTEMBER 29, PRO FORMA HUGHES SEPTEMBER 28,
1996(A) 1996(A) ADJUSTMENTS(B) PRO FORMA 1996(A)
-------------- -------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
Sales......................................... $ 547,166 $ 884,734 $ (128,659) $ 756,075 $ 257,537
Cost of sales and related occupancy
expenses.................................... 410,549 686,621 (112,781) 573,840 199,675
Marketing, general, and administrative
expenses.................................... 103,850 172,730 (19,163) 153,567 54,539
-------------- -------------- -------------- ----------- --------------
Operating income (loss)....................... 32,767 25,383 3,285 28,668 3,323
Interest income............................... 301 848 (316) 532 20
Interest expense.............................. (6,901) (2,822) 116 (2,706) (1,291)
Other income (expense)........................ 605
-------------- -------------- -------------- ----------- --------------
Earnings before income taxes.................. 26,167 23,409 3,085 26,494 2,657
Total taxes on income......................... 9,372 10,846 356 11,202 926
-------------- -------------- -------------- ----------- --------------
Income before minority interest............... 16,795 12,563 2,729 15,292 1,731
-------------- -------------- -------------- ----------- --------------
Equity losses................................. (1,391) (1,391)
Minority interest in subsidiary loss.......... 1,338 (1,338)
-------------- -------------- -------------- ----------- --------------
Net earnings.................................. $ 16,795 $ 13,901 $ -- $ 13,901 $ 1,731
-------------- -------------- -------------- ----------- --------------
-------------- -------------- -------------- ----------- --------------
Earnings per share(t)......................... $ 1.14
Weighted average shares outstanding........... 14,766
EBITDA(s)..................................... $ 46,566 $ 37,480 $ 665 $ 38,145 $ 6,227
<CAPTION>
PRO FORMA
ADJUSTMENTS
FOR QFC/HUGHES/KUI
KUI ACQUISITIONS CONSOLIDATED
PRO FORMA KUI AND PRO FORMA
ADJUSTMENTS(C) PRO FORMA OFFERINGS(D) (AS ADJUSTED)
--------------- ----------- --------------- ----------------
<S> <C> <C> <C> <C>
Sales......................................... $ (9,292) $ 248,245 $ (32,486)(m) $ 1,519,000
Cost of sales and related occupancy
expenses.................................... (8,360) 191,315 (26,516)(m) 1,149,188
Marketing, general, and administrative
expenses.................................... (2,026) 52,513 (7,982)(m) 307,432
5,484(o)
------- ----------- --------------- ----------------
Operating income (loss)....................... 1,094 4,417 (3,472) 62,380
Interest income............................... 20 853
Interest expense.............................. (1,291) (14,694) (p) (25,592)
Other income (expense)........................ (381) 224 224
------- ----------- --------------- ----------------
Earnings before income taxes.................. 713 3,370 (18,166) 37,865
Total taxes on income......................... 242 1,168 (4,819)(q) 16,923
------- ----------- --------------- ----------------
Income before minority interest............... 471 2,202 (13,347) 20,942
------- ----------- --------------- ----------------
Equity losses................................. (1,391)
Minority interest in subsidiary loss..........
------- ----------- --------------- ----------------
Net earnings.................................. $ 471 $ 2,202 $ (13,347) $ 19,551
------- ----------- --------------- ----------------
------- ----------- --------------- ----------------
Earnings per share(t)......................... $ 0.97
Weighted average shares outstanding........... 5,405 (e)(f 20,171
EBITDA(s)..................................... $ 569 $ 6,796 $ 1,345 $ 92,852
</TABLE>
S-38
<PAGE>
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT
OF EARNINGS FOR THE 52 WEEKS ENDED SEPTEMBER 7, 1996
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
<TABLE>
<CAPTION>
HISTORICAL HISTORICAL HISTORICAL
QFC HUGHES KUI
52 WEEKS ENDED 52 WEEKS ENDED 52 WEEKS ENDED
SEPTEMBER 7, SEPTEMBER 29, HUGHES PRO FORMA HUGHES SEPTEMBER 28,
1996(A) 1996(A) ADJUSTMENTS(B) PRO FORMA 1996(A)
------------------- -------------------- ----------------- ---------- --------------------
<S> <C> <C> <C> <C> <C>
Sales....................... $ 786,488 $1,175,393 $ (169,782) $1,005,611 $ 339,580
Cost of sales and related
occupancy expenses........ 591,806 922,789 (147,553) 775,236 264,397
Marketing, general, and
administrative expenses... 148,018 219,096 (25,138) 193,958 72,920
---------- ----------- ----------------- ---------- ----------
Operating income............ 46,664 33,508 2,909 36,417 2,263
Interest income............. 376 776 (102) 674 32
Interest expense............ (10,655) (3,840) 63 (3,777) (1,767)
Other income (expense)...... 1,638
---------- ----------- ----------------- ---------- ----------
Earnings before income
taxes..................... 36,385 30,444 2,870 33,314 2,166
Total taxes on income....... 13,042 13,654 302 13,956 727
---------- ----------- ----------------- ---------- ----------
Income before minority
interest.................. 23,343 16,790 2,568 19,358 1,439
---------- ----------- ----------------- ---------- ----------
Equity losses............... (1,309) (1,309)
Minority interest in
subsidiary loss........... 1,259 (1,259)
---------- ----------- ----------------- ---------- ----------
Net earnings (loss)......... $ 23,343 $ 18,049 $ -- $ 18,049 $ 1,439
---------- ----------- ----------------- ---------- ----------
---------- ----------- ----------------- ---------- ----------
Earnings per share(t)....... $ 1.59
Weighted average shares
outstanding............... 14,694
EBITDA(s)................... $ 66,463 $ 48,926 $ (249) $ 48,677 $ 7,019
<CAPTION>
PRO FORMA
ADJUSTMENTS FOR QFC/HUGHES/KUI
KUI ACQUISITIONS CONSOLIDATED
PRO FORMA KUI AND PRO FORMA
ADJUSTMENTS(C) PRO FORMA OFFERINGS(D) (AS ADJUSTED)
-------------- ----------- --------------- ----------------
<S> <C> <C> <C> <C>
Sales....................... $ (12,864) $ 326,716 $ (42,618)(m) $ 2,076,197
Cost of sales and related
occupancy expenses........ (11,436) 252,961 (33,961)(m) 1,586,042
Marketing, general, and
administrative expenses... (2,822) 70,098 (11,368)(m) 408,018
7,312(o)
-------------- ----------- --------------- ----------------
Operating income............ 1,394 3,657 (4,601) 82,137
Interest income............. 32 1,082
Interest expense............ (1,767) (18,093) (p) (34,292)
Other income (expense)...... (534) 1,104 1,104
-------------- ----------- --------------- ----------------
Earnings before income
taxes..................... 860 3,026 (22,694) 50,031
Total taxes on income....... 292 1,019 (5,845)(q) 22,172
-------------- ----------- --------------- ----------------
Income before minority
interest.................. 568 2,007 (16,849) 27,859
-------------- ----------- --------------- ----------------
Equity losses............... (1,309)
Minority interest in
subsidiary loss...........
-------------- ----------- --------------- ----------------
Net earnings (loss)......... $ 568 $ 2,007 $ (16,849) $ 26,550
-------------- ----------- --------------- ----------------
-------------- ----------- --------------- ----------------
Earnings per share(t)....... $ 1.32
Weighted average shares
outstanding............... 5,405 (e)(f 20,099
EBITDA(s)................... $ 660 $ 7,679 $ 1,863 $ 124,682
</TABLE>
S-39
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(a) QFC's fiscal year ends on the last Saturday in December, and its
reporting quarters consist of three 12-week quarters and a 16-week
quarter. The fiscal year ended December 30, 1995 was a 52-week year.
Hughes' fiscal year ends on the Sunday closest to the last day of
February. The fiscal year ended March 3, 1996 was a 53-week year. The
unaudited pro forma condensed consolidated balance sheet as of September
7, 1996, reflects Hughes' financial position as of September 29, 1996.
The unaudited pro forma condensed consolidated statement of earnings for
the 36 weeks ended September 7, 1996 reflects Hughes' results of
operations for the nine months ended September 29, 1996 (which covered 39
weeks).
KUI's fiscal year ends on the last Saturday in December, and each
quarter consists of a 13-week period. The fiscal year ended December 30,
1995 was a 52-week year. The unaudited pro forma condensed consolidated
balance sheet as of September 7, 1996, reflects KUI's financial position
as of September 28, 1996. The unaudited pro forma condensed consolidated
statement of earnings for the 36 weeks ended September 7, 1996 reflects
KUI's results of operations for the 39 weeks ended September 28, 1996.
The unaudited pro forma condensed consolidated statement of earnings for
the 52 weeks ended September 7, 1996 represents a 52-week period ended
September 7, 1996, September 29, 1996, and September 28, 1996 for QFC,
Hughes and KUI, respectively.
(b) Gives effect to the sale by Hughes to Stater of a 1% equity interest in
Santee, resulting in (i) Hughes (which previously owned 51% of Santee)
and Stater (which previously owned 49% of Santee) each becoming 50%
owners of Santee and (ii) Santee ceasing to be a consolidated subsidiary
of Hughes and being reflected in the accompanying Pro Forma Financial
Statements using the equity method of accounting.
(c) Gives effect to the elimination of certain assets and liabilities of
KUI, primarily related to non-grocery operations, and the elimination of
sales and certain expenses attributable to those assets and liabilities,
which were spun off by KUI prior to its acquisition by QFC.
(d) Gives effect to (i) the consummation of the Hughes Acquisition at an
assumed purchase price of $358.8 million equity value ($360.0 million
less $956,701 of shareholder loans and $209,670 preferred stock
redemption) (the "Hughes purchase price") and the allocation of the
purchase price to the acquired assets and liabilities including the
elimination of Hughes' shareholders equity in the amount of $160.8
million; and (ii) the consummation of the KUI Acquisition at a purchase
price of $95.6 million ($35.3 million paid in cash, $36.0 million paid
through the issuance of 904,646 shares of QFC Common Stock, and the
remaining $24.3 million paid through assumption of KUI indebtedness) (the
"KUI purchase price") and the allocation of the purchase price to the
acquired assets and liabilities, including the elimination of KUI's
shareholders equity in the amount of $5.0 million. The Hughes purchase
price is subject to certain adjustments, and the actual purchase price
may differ from such assumed purchase price, which would affect the
amount of financing required for the Hughes Acquisition.
Also gives effect to the financing of these Acquisitions (as shown in
the tables below) through the assumed receipt of (i) $167.2 million of
estimated total net proceeds from the Common Stock Offering; (ii) $59.6
million of borrowings under the Current Credit Facility to finance the
$35.3 million cash portion of the KUI purchase price and to repay the
$24.3 million in debt assumed in the KUI Acquisition; (iii) $247.9
million estimated total net proceeds under the assumed terms of the New
Credit Facility; and (iv) $145.9 million estimated total net proceeds
from the Notes Offering. Related deferred financing and other fees are
estimated to be $6.2 million ($2.1 million
S-40
<PAGE>
under the New Credit Facility and $4.1 million under the Notes Offering).
These fees will be amortized based on the life of the related debt.
Using the net proceeds from the above described borrowings, management
intends to repay borrowings of $209.6 million as reflected in the tables
below.
<TABLE>
<S> <C>
Adjustments to cash:
Net proceeds from Common Stock Offering........................ $ 167,194
Net proceeds under New Credit Facility......................... 247,915
Net proceeds from Notes Offering............................... 145,891
Borrowings under Current Credit Facility....................... 59,600
Repayment of borrowings under Current Credit Facility.......... (209,600)
Hughes purchase price.......................................... (358,834)
Cash portion of KUI purchase price............................. (35,349)
Repayment of KUI debt.......................................... (24,283)
---------
Net adjustment to cash..................................... $ (7,466)
---------
---------
Adjustments to the current portion of long-term debt:
Repayment of borrowings under Current Credit Facility.......... $ (18,900)
Repayment of KUI debt.......................................... (2,662)
---------
Net adjustment to current portion of long-term debt........ $ (21,562)
---------
---------
Adjustments to long-term debt:
Borrowings under New Credit Facility........................... $ 250,000
Borrowings from Notes Offering................................. 150,000
Borrrowings under Current Credit Facility...................... 59,600
Repayment of borrowings under Current Credit Facility.......... (190,700)
Repayment of KUI debt.......................................... (21,621)
---------
Net adjustment to long-term debt........................... $ 247,279
---------
---------
</TABLE>
(e) Gives effect to the issuance of 4,500,000 shares of QFC Common Stock in
the Common Stock Offering, net of estimated issuance costs of $8.3
million, for net proceeds of $167.2 million.
(f) Gives effect to the issuance of 904,646 shares of QFC Common Stock at a
market value of $39.75 per share to KUI shareholders as partial
consideration for the KUI Acquisition.
(g) Gives effect to the elimination of the Hughes and KUI shareholders'
equity, in the amounts shown below:
<TABLE>
<S> <C>
Hughes shareholders' equity....................................... $ 160,771
KUI shareholders' equity.......................................... 4,951
---------
$ 165,722
---------
---------
</TABLE>
(h) Gives effect to the elimination of Hughes and KUI historical LIFO
reserves, in the amounts shown below:
<TABLE>
<S> <C>
Elimination of Hughes historical LIFO reserves.................... $ 17,068
Elimination of KUI historical LIFO reserves....................... 6,798
---------
$ 23,866
---------
---------
</TABLE>
S-41
<PAGE>
(i) Gives effect to the estimated write-up to estimated fair value of Hughes
buildings, fixtures and equipment, in the amount of $20.0 million and KUI
land in the amount of $3.0 million, as of the dates of the respective
Acquisitions.
(j) Gives effect to the estimated write-up to estimated fair value of Hughes
and KUI leasehold interest as of the dates of the respective
Acquisitions, in the amounts shown below:
<TABLE>
<S> <C>
Estimated write-up of Hughes leasehold interest................... $ 55,000
Estimated write-up of KUI leasehold interest...................... 20,000
---------
$ 75,000
---------
---------
</TABLE>
(k) Gives effect to the excess of the estimated Hughes and KUI purchase
prices over the respective fair value of the net tangible assets acquired
as of the dates of the respective Acquisitions, in the amounts shown
below:
<TABLE>
<S> <C>
Estimated Hughes goodwill......................................... $ 105,995
Estimated KUI goodwill............................................ 30,630
---------
$ 136,625
---------
---------
</TABLE>
(l) Gives effect to the estimated write-up to estimated fair value of KUI's
investment in Associated Grocers as of the date of the KUI Acquisition,
in the amount of $5.9 million.
(m) Management intends to divest five of the recently acquired KUI stores.
The estimated value of such assets is $9.6 million and has been reflected
in the pro forma balance sheet as assets held for sale. The pro forma
statements of earnings give effect to the proposed divestiture of these
five stores as if it had occurred at the beginning of the periods
presented, and reflect the elimination of these stores from results of
operations for those periods. QFC has not entered into any agreements to
sell any of these stores, and the actual proceeds from the divestiture of
these stores will likely differ from the assumed amount reflected herein.
(n) Gives effect to $2.5 million accrual of Hughes' 50% share of the
discounted present value of management's estimated exit costs expected to
be incurred for the closure of the existing Santee dairy plant at such
time as the new dairy is operational.
(o) Gives effect to the additional depreciation and amortization expense
resulting from the allocations of the purchase price for KUI and the
estimated purchase price of Hughes to the assets acquired, including an
increase in property, plant, and equipment, leasehold interest, and
identifiable intangible assets to their estimated fair market values and
the recording of goodwill associated with the acquisitions. Goodwill is
amortized over 40 years.
(p) Reflects the adjustment to interest expense arising from (i) the
estimated borrowings described in note (d) above, assuming a weighted
average rate of approximately 7.21% per annum for borrowings under the
New Credit Facility and the Notes Offering, (ii) the corresponding
adjustments to the amortization of related deferred financing fees and
other fees and (iii) the reduction in historic interest expense of QFC
and KUI, resulting from the refinancing of outstanding debt.
(q) Gives effect to the adjustment for federal and state income taxes at a
blended statutory rate of 38%, adjusted for non-deductible depreciation
and amortization, estimated to be approximately $7.3 million for the year
ended December 30, 1995, $5.5 million for the 36 weeks ended September 7,
1996 and $7.3 million for the 52 weeks ended September 7, 1996 and the
impact of including QFC's historical operating results within a unitary
tax filing in the state of California.
S-42
<PAGE>
(r) No effect has been given to eliminate the $1.4 million non-recurring
charge, which was incurred in connection with the Recapitalization during
the first quarter of 1995.
(s) EBITDA is defined as net earnings before interest, income taxes,
depreciation, amortization, LIFO inventory charges, and if applicable,
equity in earnings/losses of unconsolidated subsidiaries, and
non-recurring and extraordinary items. EBITDA excludes union, pension and
benefit credits of $7.2 million for the year ended December 30, 1995,
$5.1 million for the 36 weeks ended September 7, 1996 and $7.7 million
for the 52 weeks ended September 7, 1996. EBITDA is a measure commonly
used in the grocery industry and is presented to assist in understanding
the Company's pro forma operating results. EBITDA is not intended to
represent cash flow from operations as defined by GAAP and should not be
considered as an alternative to net earnings, as an indicator of
operating performance or an alternative to cash flow as a measure of
liquidity. EBITDA is included herein because management believes that
certain investors find it to be a useful tool for measuring the Company's
ability to service debt.
(t) Earnings per share is based on the weighted average number of shares of
Common Stock outstanding during the period after consideration of the
dilutive effect, if any, of stock options granted. Pro forma (as
adjusted) earnings per share gives effect to the adjustments described in
footnotes (b) through (q) above.
S-43
<PAGE>
SELECTED HISTORICAL FINANCIAL DATA
SELECTED HISTORICAL FINANCIAL DATA OF QFC
The following table sets forth selected historical financial data of QFC as
of and for each of the five fiscal years in the period ended December 30, 1995
and as of and for the 36 weeks ended September 7, 1996 and September 9, 1995.
Data as of and for each of the three fiscal years in the period ended December
30, 1995 (except for data regarding stores open at the end of period, Same Store
Sales increase (decrease) and total square footage) have been derived from
financial statements of QFC audited by Deloitte & Touche LLP, independent
auditors, which are included herein. Data as of and for each of two fiscal years
ended December 26, 1992 and December 28, 1991 (except for data regarding stores
open at the end of period, Same Store Sales increase (decrease) and total square
footage) have been derived from audited financial statements of QFC which are
not included herein. Data as of and for the 36 weeks ended September 7, 1996 and
September 9, 1995 have been derived from unaudited financial statements of QFC
which, in the opinion of management, include all necessary adjustments,
consisting only of normal recurring adjustments, necessary for fair presentation
of the information. Data as of and for the 36 weeks ended September 7, 1996 and
September 9, 1995 do not purport to be indicative of results to be expected for
the full fiscal year. The following information is qualified by reference to,
and should be read in conjunction with, "Unaudited Pro Forma Condensed
Consolidated Financial Statements," "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the historical financial
statements of QFC and related notes thereto included or incorporated by
reference herein.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
36 WEEKS
ENDED
DECEMBER 28, DECEMBER 26, DECEMBER 25, DECEMBER 31, DECEMBER 30, SEPTEMBER 9,
1991 1992 1993 1994(1) 1995(2) 1995(2)
------------- ------------- ------------ ------------ ------------ ------------
<CAPTION>
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Sales........................... $ 395,151 $ 460,107 $ 518,260 $ 575,879 $ 729,856 $ 490,534
Gross Profit.................... 99,063 116,989 131,365 145,168 179,422 121,357
Marketing, General and
Administrative Expenses....... 69,076 80,144 92,468 105,956 136,645 92,476
Operating Income................ 29,987 36,845 38,897 39,212 42,777 28,881
Interest Expense................ -- -- -- -- 9,639 5,885
Net Earnings.................... 20,647 25,076 25,994 26,376 20,216 13,669
Earnings Per Share.............. 1.06 1.28 1.33 1.34 1.28 0.83
Ratio of Earnings to Fixed
Charges(3).................... 22.4x 22.7x 17.6x 15.7x 3.3x 3.5x
OTHER DATA:
EBITDA(4)....................... $ 36,797 $ 44,466 $ 48,205 $ 50,817 $ 59,567 $ 39,671
EBITDA Margin(5)................ 9.3% 9.7% 9.3% 8.8% 8.2% 8.1%
Depreciation and Amortization... $ 6,511 $ 7,782 $ 9,283 $ 11,605 $ 16,169 $ 10,715
Capital Expenditures............ 25,900 26,800 43,000 28,200 89,100 80,850
Stores Open at End of Period.... 30 33 38 45 62 61
Same Store Sales Increase
(Decrease)(6)................. 5.9% 6.5% 4.0% 0.4% (1.5%) (1.3%)
Total Square Footage............ 770,000 907,000 1,080,000 1,319,000 1,928,000 1,873,000
BALANCE SHEET DATA (AT END OF
PERIOD):
Net Working Capital............. $ 6,325 $ 18,722 $ 14,329 $ 23,776 $ 5,303 $ 3,950
Total Assets.................... 115,922 150,974 181,275 207,914 282,878 278,327
Total Debt (including current
portion)...................... -- -- -- -- 164,500 168,000
Shareholders' Equity............ 81,169 108,345 133,620 158,178 45,368 38,138
<CAPTION>
<S> <C>
36 WEEKS
ENDED
SEPTEMBER 7,
1996
------------
<S> <C>
OPERATING DATA:
Sales........................... $ 547,166
Gross Profit.................... 136,617
Marketing, General and
Administrative Expenses....... 103,850
Operating Income................ 32,767
Interest Expense................ 6,901
Net Earnings.................... 16,795
Earnings Per Share.............. 1.14
Ratio of Earnings to Fixed
Charges(3).................... 3.3x
OTHER DATA:
EBITDA(4)....................... $ 46,566
EBITDA Margin(5)................ 8.5%
Depreciation and Amortization... $ 13,589
Capital Expenditures............ 25,000
Stores Open at End of Period.... 62
Same Store Sales Increase
(Decrease)(6)................. 2.1%
Total Square Footage............ 1,990,000
BALANCE SHEET DATA (AT END OF
PERIOD):
Net Working Capital............. $ (16,903)
Total Assets.................... 293,610
Total Debt (including current
portion)...................... 150,000
Shareholders' Equity............ 64,407
</TABLE>
- ------------------------------
(1) Fiscal year ended December 31, 1994 was a 53 week fiscal year.
(2) Fiscal year ended December 30, 1995 and 36 weeks ended September 9, 1995
data include a one-time charge of $1.4 million, or $.09 per share, resulting
from the Recapitalization (as defined herein) completed in March 1995.
S-44
<PAGE>
(3) For purposes of these ratios, (i) earnings have been calculated by adding
interest expense and the estimated interest portion of rentals to earnings
before income taxes and (ii) fixed charges are comprised of interest expense
and the estimated interest portion of rentals.
(4) EBITDA is defined as net earnings before interest, income taxes,
depreciation, amortization, LIFO inventory charges, and, if applicable,
equity earnings (losses) from subsidiaries, and non-recurring and
extraordinary items. EBITDA is a measure commonly used in the grocery
industry and is presented to assist in understanding the Company's operating
results. EBITDA is not intended to represent cash flow from operations as
defined by GAAP and should not be considered as an alternative to cash flow
as a measure of liquidity or as an alternative to net earnings as an
indicator of operating performance. EBITDA is included herein because
management believes that certain investors find it to be a useful tool for
measuring the Company's ability to service its debt.
(5) EBITDA margin is calculated by dividing EBITDA by sales, in each case for
the applicable period.
(6) Same Store Sales exclude sales in stores opened or acquired during the
previous 12 months and the 53rd week of fiscal 1994.
S-45
<PAGE>
SELECTED HISTORICAL FINANCIAL DATA OF HUGHES
The following table sets forth selected historical financial data of Hughes
and its consolidated subsidiaries as of and for the five fiscal years ended
March 3, 1996, as of and for the seven months ended September 24, 1995 and as of
and for the seven months ended September 29, 1996. Data as of and for the five
fiscal years ended March 3, 1996 (except for data regarding stores open at end
of period, Same Store Sales increase (decrease) and total square footage) have
been derived from consolidated financial statements of Hughes audited by Arthur
Andersen LLP, independent certified public accountants. Data as of and for the
seven months ended September 24, 1995 and the seven months ended September 29,
1996 have been derived from unaudited consolidated statements of Hughes which,
in the opinion of Hughes' management, include all necessary adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of the information. Data as of and for the seven months ended
September 29, 1996 do not purport to be indicative of results to be expected for
the full fiscal year. During each of the periods presented, Santee was a
51%-owned subsidiary of Hughes. In November 1996, Hughes sold a 1% interest in
Santee, resulting in Santee ceasing to be a consolidated subsidiary of Hughes.
The following information should be read in conjunction with "Unaudited Pro
Forma Condensed Consolidated Financial Statements," "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the historical
consolidated financial statements of Hughes and related notes thereto included
or incorporated by reference herein.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
--------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
SEVEN MONTHS SEVEN MONTHS
ENDED ENDED
MARCH 1, FEBRUARY 28, FEBRUARY 27, FEBRUARY 26, MARCH 3, SEPTEMBER 24, SEPTEMBER 29,
1992 1993 1994 1995 1996(1) 1995 1996
--------- ------------ ------------ ------------ --------- ------------- -------------
(DOLLARS IN THOUSANDS)
OPERATING DATA:
Sales....................... $1,099,713 $1,087,274 $1,083,709 $1,110,947 $1,147,447 $ 647,486 $ 675,432
Gross Profit................ 206,556 225,024 229,084 226,085 245,496 138,414 145,522
Selling, General and
Administrative Expense.... 181,209 209,918 206,289 209,211 215,234 122,631 126,493
Operating Income............ 25,347 15,106 22,795 16,874 30,262 15,783 19,029
Interest Expense............ 3,598 1,149 4,598 4,664 4,335 2,595 2,100
Net Income.................. 14,608 8,677 11,224 8,374 16,184 8,534 10,399
OTHER DATA:
EBITDA(2)................... $ 42,807 $ 33,379 $ 40,794 $ 36,929 $ 42,439 $ 22,552 $ 29,037
EBITDA Margin(3)............ 3.9% 3.1% 3.8% 3.3% 3.7% 3.5% 4.3%
Depreciation and
Amortization.............. $ 15,597 $ 17,504 $ 19,310 $ 21,313 $ 19,571 $ 9,309 $ 12,111
Capital Expenditures........ 15,773 57,862 31,701 36,063 19,633 3,848 30,939
Stores Open at End of
Period.................... 52 51 51 53 54 54 55
Same Store Sales Increase
(Decrease)(4)............. (0.7%) (1.7%) 0.7% 1.1% (1.4%) (0.5%) 0.6%
Total Square Footage........ 1,852,000 1,855,000 1,858,000 1,942,000 1,986,000 1,986,000 2,038,000
BALANCE SHEET DATA (AT END
OF PERIOD):
Net Working Capital......... $ 24,237 $ 8,192 $ 16,526 $ 8,628 $ 16,528 $ 8,404 $ (11,448)
Total Assets................ 258,632 270,611 300,941 316,728 316,499 311,874 315,709
Total Debt (including
current portion).......... 28,516 30,303 37,247 41,984 27,463 23,784 12,248
Shareholders' Equity........ 112,756 121,077 131,289 137,975 151,544 144,590 160,771
</TABLE>
- ------------------------
(1) Fiscal year ended March 3, 1996 was a 53-week fiscal year.
(2) EBITDA is defined as net earnings before interest, income taxes,
depreciation, amortization, LIFO inventory charges, and, if applicable,
equity earnings (losses) from subsidiaries, and non-recurring and
extraordinary items. EBITDA excludes union,
S-46
<PAGE>
pension and benefit credits of $7.2 million, $3.0 million and $1.2 million
recorded by Hughes for the fiscal year ended March 3, 1996, the fiscal year
ended February 26, 1995 and the fiscal year ended February 27, 1994,
respectively, and pension and benefit credits of $2.4 million and $3.0
million recorded by Hughes for the seven months ended September 24, 1995 and
the seven months ended September 29, 1996, respectively. EBITDA is a measure
commonly used in the grocery industry and is presented to assist in
understanding Hughes' operating results. EBITDA is not intended to represent
cash flow from operations as defined by GAAP and should not be considered as
an alternative to cash flow as a measure of liquidity or as an alternative
to net earnings as an indicator of operating performance.
(3) EBITDA margin is calculated by dividing EBITDA by sales, in each case for
the applicable period.
(4) Same Store Sales exclude sales in stores opened or acquired during the
previous 12 months and the 53rd week of fiscal 1996.
S-47
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Upon consummation of both the Acquisitions, the Company will operate 84
stores in the Seattle/ Puget Sound region as well as 56 "Hughes Family Markets"
stores in Southern California. The Acquisitions will more than double the size
of the Company, and managing the Company and integrating the acquired businesses
will present a new challenge to management. In order to facilitate this phase of
the Company's development, the Company has hired a new chief executive officer
and a senior vice president for corporate development to pursue and integrate
acquisitions at a holding company level, thus allowing current senior management
to remain focused on existing operations. See "Risk Factors--Risks Relating to
Acquisition Strategy." Because of the magnitude of the Acquisitions, the
Company's operations after consummation of the Acquisitions will not be
comparable to QFC's or Hughes' historical operations prior thereto. Each of the
Hughes Acquisition and the KUI Acquisition will be accounted for under the
"purchase" method of accounting.
On March 2, 1995 the principal operations of Olson's Food Stores, Inc. were
merged into QFC (the "Olson's Merger"), including assets and liabilities related
to 12 of its grocery stores and its interest in certain grocery stores in
various stages of development, and its rights to several other future sites. The
Olson's Merger was effected through an acquisition of 100% of the outstanding
voting securities of Olson's for $18.0 million cash, 752,941 shares of QFC
Common Stock, which as of March 2, 1995 had a value of $18.1 million, and the
assumption by QFC of approximately $24.0 million of indebtedness of Olson's. The
merger was accounted for under the "purchase" method of accounting.
QFC completed a recapitalization in March 1995 (the "Recapitalization"). As
part of the Recapitalization, QFC purchased 7 million shares of its Common Stock
through a self-tender offer at a price of $25 per share. In addition, QFC sold 1
million shares of its Common Stock to Zell Chilmark at $25 per share on March
29, 1995. Zell Chilmark also acquired 2.975 million shares from QFC's chairman
and former chief executive officer in a separate transaction on January 16,
1996. In March 1995, QFC borrowed approximately $174 million under the Current
Credit Facility to finance (i) the $24 million of long-term debt assumed in the
Olson's Merger and (ii) the repurchase of its Common Stock pursuant to the self-
tender offer. Due to these developments, QFC's financial statements for 1995 and
subsequent periods have changed significantly, reflecting lower cash balances, a
significant reduction in shareholders' equity and increase in long-term debt,
and a related reduction in interest income and increase in interest expense.
Further, during the first quarter of fiscal 1995, QFC recorded a one-time charge
of $1.4 million for nondeductible expenses associated with the Recapitalization.
The remaining $2.9 million of expenses paid in connection with the
Recapitalization were recorded as a direct reduction to shareholders' equity.
Set forth below is (i) a discussion of the financial condition and results
of operations of QFC for the 36 weeks ended September 7, 1996 and the three
fiscal years ended December 30, 1995 and (ii) a discussion of the financial
condition and results of operations of Hughes for the seven months ended
September 29, 1996 and the three fiscal years ended March 3, 1996.
QUALITY FOOD CENTERS, INC.
QFC's fiscal year generally consists of three 12-week quarters and one
16-week quarter, although fiscal year 1994 comprised 53 weeks of operations.
QFC's sales and operating income have increased each year since QFC's
initial public offering in 1987, driven primarily by acquisitions and opening of
new stores and the expansion and remodeling of existing stores. In addition,
management believes that, for the fiscal year ended December 30, 1995, QFC's
EBITDA margin, and its operating income as a percentage of sales, were well in
excess of the average for
S-48
<PAGE>
the supermarket industry. The following table provides information pertaining to
QFC's sales increases over the three fiscal years ended December 30, 1995 and
over the 36 weeks ended September 7, 1996.
<TABLE>
<CAPTION>
CHANGE FROM PRIOR FISCAL YEAR
-------------------------------------------------------
YEAR ENDED YEAR ENDED YEAR ENDED CHANGE FROM
DECEMBER 25, DECEMBER 31, DECEMBER 30, 36 WEEKS ENDED SEPTEMBER 9, 1995 TO
1993 1994 1995 36 WEEKS ENDED SEPTEMBER 7, 1996
----------------- ----------------- ----------------- ---------------------------------------
<S> <C> <C> <C> <C>
Total sales increase.............. 12.6% 11.1% 26.7% 11.5%
Store square footage increase..... 19.0% 22.1% 46.2% 6.5%
Same Store Sales increase
(decrease)(1)................... 4.0% 0.4% (1.5)% 2.1%
</TABLE>
- ------------------------
(1) Same Store Sales exclude sales in stores opened or acquired during the
previous 12 months and the 53rd week of fiscal 1994.
QFC's sales increases during 1993-1995 were lower than the increases in
store square footage because the majority of square footage added was from new
and acquired stores open for a partial year, which stores' sales per square foot
were significantly lower than newly remodeled or older, more mature stores.
Sales per square foot of selling space were $681, $619 and $548 in fiscal
1993, 1994 and 1995, respectively. This trend and the decreases in same store
sales during fiscal years 1994 and 1995 were the result of several factors,
including: (i) new, larger and less mature stores became a more significant part
of QFC's sales, (ii) older stores were maturing to a level where substantial
sales growth was more difficult and (iii) QFC experienced food price deflation
combined with a softer regional economy. In addition to these factors, the
decreases in 1995 were largely due to QFC experiencing lower sales in certain
existing stores due to QFC's competitors opening, replacing or remodeling an
unusually large number of stores located near QFC's stores during the fourth
quarter of 1994 and throughout 1995, combined with 1994 sales that were higher
than normal in QFC's affected stores due to the closure of certain of these
competitors' stores while they were being remodeled or replaced. In addition,
QFC followed a strategy of opening stores in certain locations intended to
enhance QFC's competitive position and protect its market share but that reduced
sales in its nearby existing stores.
Sales per square foot of selling space was $538 for the 36 weeks ended
September 7, 1996, as compared to $550 for the 36 weeks ended September 9, 1995,
in each case on an annualized basis. Over the 36 weeks ended September 7, 1996,
the Company's same store sales (which, for such period (unlike the comparable
period in fiscal year 1995), exclude sales in stores opened or acquired during
the previous 36 weeks) increased by approximately 2.1%, with an increase of
approximately 3.4% in the third quarter of fiscal 1996. These increases were the
result of several factors, including: (i) increased sales from QFC's recently
expanded and remodeled stores, including sales from 10 stores that had been
remodeled, and eight stores that had been re-remodeled, during the past two
years, (ii) the passing of the anniversaries of certain QFC and competitors'
store openings and remodelings which affected results in the comparable period
in 1995 and (iii) a stronger regional economy than in recent years.
The Company added, through both acquisitions and new store openings, five
stores in fiscal 1993, seven stores in fiscal 1994, 17 stores (12 of which were
acquired in the Olson's Merger) in 1995 and two stores in 1996.
S-49
<PAGE>
The table below sets forth items in QFC's statements of earnings as a
percentage of sales:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED 36 WEEKS ENDED
------------------------------------------------- ---------------
<S> <C> <C> <C> <C>
DECEMBER 25, DECEMBER 31, DECEMBER 30, SEPTEMBER 9,
1993 1994 1995 1995
--------------- --------------- --------------- ---------------
Sales............................................ 100.0% 100.0% 100.0% 100.0%
Cost of Sales and Related Occupancy Expenses..... 74.7 74.8 75.4 75.3
----- ----- ----- -----
Gross Margin..................................... 25.3 25.2 24.6 24.7
Marketing, General and Administrative Expenses... 17.8 18.4 18.7 18.8
----- ----- ----- -----
Operating Income................................. 7.5 6.8 5.9 5.9
Interest Income.................................. 0.2 0.2 0.1 0.1
Interest Expense................................. -- -- (1.3) (1.2)
Other Expense.................................... -- -- (0.2) (0.3)
----- ----- ----- -----
Earnings Before Income Taxes..................... 7.7 7.0 4.5 4.5
Taxes on Income.................................. 2.7 2.4 1.7 1.7
----- ----- ----- -----
Net Earnings..................................... 5.0% 4.6% 2.8% 2.8%
----- ----- ----- -----
----- ----- ----- -----
EBITDA Margin.................................... 9.3% 8.8% 8.2% 8.1%
<CAPTION>
<S> <C>
SEPTEMBER 7,
1996
---------------
Sales............................................ 100.0%
Cost of Sales and Related Occupancy Expenses..... 75.0
-----
Gross Margin..................................... 25.0
Marketing, General and Administrative Expenses... 19.0
-----
Operating Income................................. 6.0
Interest Income.................................. 0.1
Interest Expense................................. (1.3)
Other Expense.................................... --
-----
Earnings Before Income Taxes..................... 4.8
Taxes on Income.................................. 1.7
-----
Net Earnings..................................... 3.1%
-----
-----
EBITDA Margin.................................... 8.5%
</TABLE>
RESULTS OF OPERATIONS
THIRTY-SIX WEEKS ENDED SEPTEMBER 7, 1996 COMPARED TO THIRTY-SIX WEEKS ENDED
SEPTEMBER 9, 1995
SALES
Sales for the 36 weeks ended September 7, 1996 increased $56.6 million, or
11.5%, as compared with the comparable period in 1995. The increase reflected:
(i) the addition of 17 stores (12 of which were acquired in the Olson's Merger
on March 2, 1995, three of which were acquired on March 29, 1995 from another
independent operator, one acquired store that opened in August 1995 and a new
store that opened in November 1995), (ii) higher sales in remodeled stores and
(iii) an increase in same store sales of approximately 2.1% with no significant
food price inflation. These factors 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 was impacted by (i) new and
acquired stores (which typically have lower sales volumes) becoming a more
significant part of sales, (ii) the maturing of older stores to a level where
substantial sales growth is more difficult and (iii) QFC's strategy of opening
and acquiring stores in certain locations intended to enhance QFC's competitive
position and protect its market share but that reduced sales in its nearby
existing stores. Additionally, the supermarket industry continued to be highly
competitive.
COST OF SALES AND RELATED OCCUPANCY EXPENSES
QFC's cost of sales and related occupancy expenses decreased to 75.0% of
sales for the 36 weeks ended September 7, 1996, as compared to 75.3% for the
comparable period in 1995. The improvement in cost of sales and related
occupancy expenses was primarily a result of improved buying and merchandising
and a greater mix of sales in higher margin service departments, which more than
offset higher occupancy expenses resulting from the 1995 acquisitions and
construction of new stores.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES
Marketing, general and administrative expenses increased to 19.0% of sales
for the 36 weeks ended September 7, 1996, as compared to 18.8% of sales for the
comparable period in 1995. The increase in these expenses was primarily
attributable to contractual rate increases from union contracts effective in May
and August of 1996 and a 10% increase in the union benefit contributions rate
effective in July 1996 as well as
S-50
<PAGE>
to additional startup and promotional expenses incurred in connection with
remodels completed during the third quarter.
OPERATING INCOME
Operating income increased 13.5% for the 36 weeks ended September 7, 1996,
as compared to the comparable period in 1995, reflecting an 11.5% increase in
sales and an increase in operating margins to 6.0% of sales from 5.9% of sales
in the comparable period in 1995.
INTEREST INCOME
Interest income decreased by $125,000 for the 36 weeks ended September 7,
1996, as compared to the comparable period in 1995, reflecting lower average
cash balances as a result of the Recapitalization which was completed on March
29, 1995.
INTEREST EXPENSE
Interest expense was impacted by the interest on the debt assumed (and
refinanced) in the Olson's Merger which was completed on March 2, 1995 and debt
incurred in connection with the Recapitalization. Interest expense is reported
net of interest capitalized in connection with store construction and remodeling
costs.
Interest expense increased $1.0 million to $6.9 million (net of $0.9 million
of capitalized interest) for the 36 weeks ended September 7, 1996, as compared
to the comparable period in 1995 as all 36 weeks in 1996 reflected interest
associated with QFC's debt incurred in March 1995 in connection with the
Recapitalization, as compared to only 23 weeks in the comparable period in 1995.
OTHER EXPENSE
QFC incurred a one-time charge of $1.4 million in the first quarter of 1995
for fees paid in connection with the Recapitalization. This charge is not
deductible for federal income tax purposes. The remaining costs of approximately
$2.9 million incurred in connection with the Recapitalization were recorded as a
reduction in shareholders' equity.
INCOME TAXES
QFC's effective federal income tax rate decreased to 35.8% for the 36 week
period ended September 7, 1996, as compared to an effective tax rate of 37.9%
for the 36 weeks ended September 9, 1995 as a result of the non-deductible
one-time charge of $1.4 million recorded as other expense in the first quarter
of 1995. The difference between QFC's effective income tax rate and the federal
statutory rate for 1996 was primarily due to the non-deductible amortization of
goodwill and certain other assets that were recorded in connection with the
Olson's Merger.
NET EARNINGS
Net earnings for the 36 weeks ended September 7, 1996 increased by 22.9% to
$16.8 million, as compared to $13.7 million for the comparable period in 1995.
The increase was due to (i) the 13.5% increase in operating income, (ii) the
$1.4 million decrease in other expense and (iii) the decrease in the effective
tax rate offset by higher interest expense. Earnings per share were $1.14 per
share on 14,766,000 weighted average shares outstanding, as compared with $0.83
per share on 16,401,000 weighted average shares outstanding for the comparable
period in 1995. Excluding the one-time charge of $1.4 million for other expense,
net earnings for 1995 would have been $15.1 million, or $0.92 per share.
S-51
<PAGE>
FISCAL YEAR ENDED DECEMBER 30, 1995 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
1994;
FISCAL YEAR ENDED DECEMBER 31, 1994 COMPARED TO FISCAL YEAR ENDED DECEMBER 25,
1993
SALES
Sales for 1995 were $729.9 million, an increase of $154 million, or 26.7%,
as compared to 1994. However, fiscal 1994 included 53 weeks of operations, as
compared to only 52 weeks in both 1995 and 1993. Excluding the impact of the
53rd week in 1994, sales would have increased 29% relative to 1994. This sales
increase was due primarily to the acquisition of 16 stores and construction of
one new store in 1995. Sales for 1994 were $575.9 million, an increase of $57.6
million, or 11.1%, as compared to sales of $518.3 million for 1993, reflecting
the addition of seven stores and the additional week due to 1994 being a 53-week
year.
COST OF SALES AND RELATED OCCUPANCY EXPENSES
Cost of sales and related occupancy expenses as a percentage of sales
increased 0.6% in 1995 due primarily to lower margins and higher occupancy
expenses in the new and acquired stores due to the larger square footage and
higher rent structure in the newer stores. Also, due to the slight inflation
during the fourth quarter of 1995, QFC recorded a $619,000 charge for its
last-in, first-out (LIFO) inventory method, whereas the adjustment for LIFO
inventory resulted in no change in cost of sales in 1994 and an increase of
$25,000 in 1993.
The slight increase in cost of sales in 1994 was due primarily to (i)
promotional pricing for the opening of new and remodeled stores, (ii) ongoing
competitive pricing and (iii) rising occupancy costs, including depreciation and
amortization resulting from new and remodeled stores. The impact of these
factors on gross margin over the three fiscal years ended December 30, 1995 was
largely mitigated by a larger portion of sales coming from higher margin service
departments, more effective merchandising and buying, and reduced inventory
shrinkage due to improved systems and controls.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES
Marketing, general and administrative expenses (operating expenses), as a
percentage of sales, increased 0.3% to 18.7% of sales in 1995 after a 0.6%
increase as a percentage of sales in 1994. These increases resulted from various
factors. While sales reflected continued food price deflation, rates for certain
operating expenses, such as store labor and utilities, continued to increase and
the decline in sales in stores affected by competitive store openings resulted
in deleveraging of operating expenses. Also, lower sales per square foot and
higher expenses associated with new stores had an impact on operating expenses.
Operating expenses in 1995 also included an additional $1.7 million in
amortization arising from intangibles created in connection with the 1995
acquisitions. These expense increases were partially offset during the fourth
quarter when QFC's chairman and then chief executive officer received stock
options in lieu of a management fee, which would have been approximately
$479,000.
OPERATING INCOME
Operating income increased 9.1% in 1995 after an increase of less than 1% in
1994. Operating margins decreased from 7.5% of sales in 1993 to 6.8% of sales in
1994 and 5.9% of sales in 1995. The declines were due to higher cost of sales
and occupancy expenses and higher operating expenses as described above.
S-52
<PAGE>
INTEREST INCOME
Interest income decreased $431,000 during the year ended December 30, 1995,
as compared to the same period in 1994, reflecting lower cash balances due
primarily to the Recapitalization. Interest income increased $53,000 in 1994
over 1993 due to higher cash balances and interest rates.
INTEREST EXPENSE
Interest expense of $9.6 million for 1995 reflected interest on the debt
assumed (and refinanced) in the Olson's Merger and debt incurred in connection
with the Recapitalization. Interest expense was net of approximately $167,000 of
interest capitalized in connection with store construction and remodeling costs
incurred during 1995. QFC had no borrowings or related interest expense in 1994
or 1993.
INCOME TAXES
QFC's effective income tax rate was 37.3% for 1995 due to the nondeductible
amortization of goodwill and certain other assets that were included in the
Olson's Merger and the nondeductible $1.4 million charge relating to the
Recapitalization. This compares to an effective tax rate of 34.3% in 1994 and
34.7% in 1993.
NET EARNINGS
While 1995 operating income was higher than in 1994, net earnings declined
from $26.4 million to $20.2 million due to an increase in net interest expense
of $10 million, the higher effective tax rate and the $1.4 million one-time
charge incurred in connection with the Recapitalization. Reflecting the new
capital structure following the Recapitalization, weighted average shares
outstanding declined from 19.7 million in 1994 to $15.8 million in 1995.
Earnings per share were $1.28 for 1995 compared with $1.34 in 1994 and $1.33 in
1993. Excluding the $1.4 million one-time charge, net earnings and earnings per
share in 1995 would have been $21.6 million and $1.36, respectively. Higher
operating and interest income and a slightly lower effective tax rate than in
1993 resulted in a 1.5% increase in net earnings in 1994 to $26.4 million.
ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation," was recently issued and was effective for QFC's
fiscal year ended December 28, 1996. QFC, as allowed, intends to continue to
measure stock-based compensation using its current method of accounting
prescribed by Accounting Principles Board (APB) Opinion No. 25. Although the
Company will be required to disclose certain additional information related to
its stock options and employee stock purchase plans, management believes the
impact to the financial statements, taken as a whole, will not be material.
INFLATION
QFC's sales for the 36 weeks ended September 7, 1996 reflected no
significant food price inflation or deflation, while sales for the comparable
period in 1995 reflected food price deflation of approximately 1%. In 1995,
QFC's sales reflected food price deflation of nearly 1% in the first two
quarters, flat prices in the third quarter, and after more than three years of
deflation, food price inflation of approximately 0.5% during the fourth quarter.
During 1994 and 1993, QFC's sales reflected food price deflation of
approximately 1.4% and less than 1%, respectively.
S-53
<PAGE>
HUGHES MARKETS, INC.
Hughes' fiscal year ends on the Sunday closest to the last day of February.
Fiscal year 1996 was a 53 week year while fiscal 1995 and fiscal 1994 covered 52
weeks. The seven months ended September 24, 1995 and September 29, 1996 covered
30 weeks.
Over the two fiscal years ended March 3, 1996 and the seven months ended
September 29, 1996, sales increases were driven primarily by the addition of new
stores and the remodeling of existing stores.
<TABLE>
<CAPTION>
CHANGE FROM PRIOR FISCAL YEAR
---------------------------------------------------
YEAR ENDED YEAR ENDED YEAR ENDED CHANGE FROM
FEBRUARY 27, FEBRUARY 26, MARCH 3, SEVEN MONTHS ENDED SEPTEMBER 24, 1995 TO
1994 1995 1996 SEVEN MONTHS ENDED SEPTEMBER 29, 1996
--------------- ----------------- --------------- ---------------------------------------------
<S> <C> <C> <C> <C>
Total sales increase
(decrease).................... (0.3)% 2.5% 3.3% 4.3%
Store square footage increase... 0.2% 4.5% 2.3% 2.6%
Same Store Sales increase
(decrease)(1)................. 0.7% 1.1% (1.4)% 0.6%
</TABLE>
- ------------------------
(1) Same Store Sales exclude sales in stores opened or acquired during the
previous 12 months and the 53rd week of fiscal 1996.
Hughes' sales increases during fiscal year 1995 and the seven months ended
September 29, 1996 were lower than the increases in store square footage because
the majority of square footage added was from new stores open for a partial
year, which stores' sales per square foot were significantly lower than newly
remodeled or older, more mature stores.
Sales per square foot of selling space were $842, $813 and $802 (excluding
the 53rd week of fiscal 1996) in fiscal 1994, 1995 and 1996, respectively. This
trend and the decrease in same store sales in fiscal 1996 was the result of
several factors, including (i) new, larger and less mature stores became a more
significant part of Hughes' sales, (ii) older stores were maturing to a level
where substantial sales growth was more difficult and (iii) Hughes experienced
lower sales in certain existing stores due to Hughes' competitors opening,
replacing or remodeling a number of stores located near Hughes' stores. Sales
per square foot of selling space increased from an annualized rate of $794 for
the seven months ended September 24, 1995 to $802 for the seven months ended
September 29, 1996 and same store sales increased due to the closure of an
underperforming store in 1996, the timing of new store openings and improvement
in the Southern California economy.
For each of the three fiscal years ended March 3, 1996, and for the seven
months ended September 29, 1996, Santee was a 51%-owned subsidiary of Hughes,
and the accounts of Santee were included in Hughes' consolidated financial
statements for those periods. In November 1996, Hughes sold a 1% equity interest
in Santee to Stater (which previously owned 49% of Santee), resulting in (i)
Hughes and Stater each becoming 50% owners of Santee and (ii) Santee ceasing to
be a consolidated subsidiary of Hughes. As a result, for periods subsequent to
the sale of this 1% interest to Stater, Santee will be accounted for using the
equity method of accounting. See "Unaudited Pro Forma Condensed Consolidated
Financial Statements."
S-54
<PAGE>
The table below sets forth items in Hughes' consolidated statements of
income as a percentage of sales:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SEVEN MONTHS ENDED
--------------------------------------------- --------------------------------
<S> <C> <C> <C> <C> <C>
FEBRUARY 27, FEBRUARY 26, MARCH 3, SEPTEMBER 24, SEPTEMBER 29,
1994 1995 1996 1995 1996
--------------- --------------- ----------- --------------- ---------------
Sales........................................ 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of Sales, including Distribution and
Occupancy Expenses......................... 78.9 79.6 78.6 78.6 78.5
----- ----- ----- ----- -----
Gross Margin................................. 21.1 20.4 21.4 21.4 21.5
Selling, General & Administrative Expenses... 19.0 18.8 18.8 19.0 18.7
----- ----- ----- ----- -----
Operating Income............................. 2.1 1.6 2.6 2.4 2.8
Interest Income.............................. 0.1 0.1 0.2 0.2 0.1
Interest Expense............................. (0.4) (0.4) (0.4) (0.4) (0.3)
----- ----- ----- ----- -----
Earnings Before Income Taxes and Minority
Interest................................... 1.8 1.3 2.4 2.2 2.6
Income Taxes................................. 0.8 0.6 1.0 0.9 1.2
Minority Interest in Subsidiary Loss......... -- 0.1 -- -- 0.1
Net Income................................... 1.0% 0.8% 1.4% 1.3% 1.5%
----- ----- ----- ----- -----
----- ----- ----- ----- -----
EBITDA Margin................................ 3.8% 3.3% 3.7% 3.5% 4.3%
</TABLE>
RESULTS OF OPERATIONS
SEVEN MONTHS ENDED SEPTEMBER 29, 1996 COMPARED TO SEVEN MONTHS ENDED SEPTEMBER
24, 1995
SALES
Sales for the seven months ended September 29, 1996 increased $27.9 million,
or 4.3%, as compared to the comparable period in 1995. This increase reflected
slightly higher same store sales of 0.6% and the impact of the net addition of
two new stores during the seven months ended September 29, 1996. Two remodels
were also completed in the first seven months of 1996 and a new store was opened
in September 1995. Santee's sales (15% of consolidated sales for the seven
months ended September 29, 1996) increased 9% as compared to the comparable
period in 1995, primarily due to the pass-through of a portion of raw milk cost
increases to its customers.
COST OF SALES, INCLUDING DISTRIBUTION AND OCCUPANCY EXPENSES
Cost of sales, including distribution and occupancy expenses, was 78.5% of
sales for the seven months ended September 29, 1996, as compared to 78.6% of
sales for the comparable period in 1995. The slight improvement was primarily
the result of improved buying and an increase in the proportion of higher margin
products in the overall sales mix. In addition, Hughes' management believes that
recent improvements in the Southern California economy contributed to this
improvement. See "Business--Market Overview." Offsetting a portion of these
improvements was a higher last-in-first-out ("LIFO") adjustment of approximately
$1.0 million, together with higher occupancy expenses related to new stores.
Santee's cost of sales increased in 1996 as compared to 1995, as raw material
cost increases outpaced sales price increases to customers. Santee's occupancy
expenses increased during the seven months ended September 29, 1996 as compared
to the comparable period in 1995 because of increased rent expense resulting
from the expected early termination of the existing dairy lease and the
accelerated depreciation of its leasehold interest and equipment at the existing
dairy plant.
S-55
<PAGE>
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased to 18.7% of sales for
the seven months ended September 29, 1996, as compared to 19.0% of sales for the
comparable period in 1995. This reduction in expenses was due primarily to
increased benefit credits related to the Southern California UFCW and Food
Employers Joint Pension Trust Fund and Benefit Fund (the "Food Employers Funds")
($3.0 million of credits for the seven months ended September 29, 1996, as
compared to $2.4 million of credits for the comparable period in 1995). The Food
Employers Funds were overfunded principally due to large contributions by
employers, higher than normal investment returns and cost containment of certain
medical benefits. As a result, the Food Employers Funds received credits in the
form of suspended contributions. Santee's selling, general and administrative
expenses remained stable and thus contributed to the overall improvement in
1996.
OPERATING INCOME
Operating income increased 21% for the seven months ended September 29, 1996
as compared to the comparable period in 1995, reflecting the 4.3% increase in
sales and an increase in operating margins to 2.8% of sales from 2.4% of sales
for the comparable period in 1995. This increase was due to improved gross
margins and lower selling, general and administrative expenses.
INTEREST INCOME
Interest income decreased approximately $0.5 million for the seven months
ended September 29, 1996 as compared to the comparable period in 1995,
reflecting lower average cash balances due to the repayment of debt and the
making of capital expenditures, including $5.7 million for the purchase by
Santee of land for the construction of the new dairy plant. See "Risk
Factors--Risks Relating to Santee Dairies."
INTEREST EXPENSE
Interest expense decreased by approximately $0.5 million for the seven
months ended September 29, 1996 as compared to the comparable period in 1995,
reflecting lower average debt levels. Long-term debt, including the current
portion thereof, was $12.2 million at September 29, 1996, as compared to $23.8
million at September 24, 1995.
INCOME TAXES
Hughes' income tax expense reflects the federal statutory rate of 35%
combined with the state of California's rate of 9.3% for a blended rate of
approximately 41%. Hughes' consolidated effective tax rate is higher than this
level because no federal benefit and only a partial state benefit was allowed
due to recurring losses at Santee. Hughes' effective income tax rate was 48% for
the seven months ended September 29, 1996, as compared to 43% for the comparable
period in 1995.
MINORITY INTEREST IN SUBSIDIARY LOSS
During the seven month period ended September 29, 1996, Hughes owned 51% of
Santee and, therefore, the 49% minority ownership in Santee's losses was added
back to Hughes' income. Santee incurred $2.4 million in total operating losses
in the seven months ended September 29, 1996 as compared to $0.6 million in the
comparable period in 1995, due to increased occupancy costs and lower margins,
as a result of increased rent expense resulting from the expected early
termination of the existing dairy lease and the accelerated depreciation of its
leasehold interest and equipment at the existing dairy plant, as well as raw
material costs outpacing sales price increases to customers. See "Risk
Factors--Risks Relating to
S-56
<PAGE>
Santee Dairies." In addition, Santee's cost of sales increased during the seven
months ended September 29, 1996 as compared to the comparable period in 1995, as
raw materials cost increases outpaced sales price increases to customers.
NET INCOME
Net income totaled $10.4 million for the seven months ended September 29,
1996, as compared to $8.5 million for the comparable period in 1995. This 22%
increase was due to the 21% increase in consolidated operating income.
FISCAL YEAR ENDED MARCH 3, 1996 COMPARED TO FISCAL YEAR ENDED FEBRUARY 26, 1995;
FISCAL YEAR ENDED FEBRUARY 26, 1995 COMPARED TO FISCAL YEAR ENDED FEBRUARY 27,
1994
SALES
Sales for fiscal 1996 were $1.1 billion, an increase of $37 million, or
3.3%, as compared to fiscal 1995. Excluding the impact of the 53rd week in 1996,
sales would have been $1,129 million, a 2% increase over fiscal 1995. The
overall sales increase in fiscal 1996 as compared to fiscal 1995 was due
primarily to the impact of one new store and four remodels during the year. Same
store sales decreased 1.4% in fiscal 1996 due primarily to Hughes' competitors
opening, replacing or remodeling a number of stores located near Hughes' stores.
Santee's sales (14% of consolidated sales in fiscal 1996) were 3% higher in
fiscal 1996 as compared to fiscal 1995, primarily due to the pass through of a
portion of raw milk cost increases to its customers and substantial increases in
co-pack and bulk dairy sales.
Sales for fiscal 1995 were $1.1 billion, an increase of $27 million, or
2.5%, as compared to fiscal 1994. Same store sales increased 1.1% in fiscal 1995
and two new stores and four remodels also favorably impacted fiscal 1995 sales
as compared to fiscal 1994. During fiscal 1994, no new Hughes stores were opened
although six stores were remodeled. Santee's sales (14% of consolidated sales in
fiscal 1995) were 1.6% higher in fiscal 1995 as compared to fiscal 1994,
primarily due to the pass through of raw milk cost increases to Santee's
customers.
COST OF SALES, INCLUDING DISTRIBUTION AND OCCUPANCY EXPENSES
Cost of sales, including distribution and occupancy expenses, were 78.6% of
sales in fiscal 1996, as compared to 79.6% of sales in fiscal 1995. The
improvement was in part the result of improved buying and an increase in the
proportion of higher margin products in the overall sales mix. Offsetting some
of these improvements were higher occupancy expenses related to new stores.
Hughes' cost of sales also benefited from a positive LIFO provision of $0.2
million in fiscal 1996, as compared to $1.8 million charge in fiscal 1995.
Santee's cost of sales, as a percentage of its sales, rose approximately 1% in
fiscal 1996 as compared to fiscal 1995, primarily reflecting a substantial unit
increase in lower margin co-pack and bulk lines of business and increased raw
milk costs which Santee could not fully recover through increased selling
prices.
Cost of sales, including distribution and occupancy expenses, were 79.6% of
sales in fiscal 1995, as compared to 78.9% of sales in fiscal 1994. The increase
was due in part to lower initial margins at the two new stores and higher
occupancy costs associated with newer stores. In fiscal 1995, an improvement in
the gross margin was more than offset by an increase of $1.9 million in the LIFO
charge. Santee's cost of sales, as a percentage of its sales, increased
approximately 2% in fiscal 1995 as compared to fiscal 1994, primarily reflecting
an increase in depreciation expense.
S-57
<PAGE>
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses were 18.8%, 18.8% and 19.0% of
sales in fiscal 1996, 1995 and 1994, respectively. Included in the 1996 expenses
were higher store labor, profit sharing and advertising expenses, as compared to
fiscal 1995. Offsetting these expense increases were lower pension and benefit
expenses ($7.2 million, $3.0 million and $1.2 million of benefit credits were
recorded in fiscal 1996, 1995 and 1994, respectively). Excluding these benefit
credits, selling, general and administrative expenses would have been 19.4%,
19.1% and 19.1% of sales in fiscal years 1996, 1995 and 1994, respectively.
OPERATING INCOME
Operating income was $30.3 million in fiscal 1996, an increase of 79% as
compared to fiscal 1995. This reflected a sales increase of 3.3% and an increase
in operating margins to 2.6% of sales from 1.6% of sales in fiscal 1995, which
was attributable primarily to higher gross profit margins and lower employee
benefit expenses. Operating income for fiscal year 1995 decreased $5.9 million
from fiscal 1994 due to a 0.5% decline in operating margin as higher cost of
sales were only partially offset by lower selling, general and administrative
expenses.
INTEREST INCOME
Interest income was $1.3 million, $1.1 million and $0.8 million in fiscal
1996, 1995 and 1994, respectively. The increases have been due to increasing
average cash balances .
INTEREST EXPENSE
Interest expense remained stable, at approximately 0.4% of sales, in each of
fiscal 1996, 1995 and 1994.
INCOME TAXES
Hughes' effective income tax rates were 42%, 43% and 42% in fiscal 1996,
1995 and 1994, respectively. These rates are higher than Hughes' blended federal
and state corporate tax rate of approximately 41% because of continued operating
losses at Santee for which no tax benefit has been recorded at this time.
MINORITY INTEREST IN SUBSIDIARY LOSS
During fiscal 1996, 1995 and 1994, Hughes owned 51% of Santee and,
therefore, the 49% minority ownership in Santee's losses was added back to
Hughes' income. The 49% minority share of Santee's operating losses were $0.4
million, $0.7 million and $0.2 million in fiscal 1996, 1995 and 1994,
respectively. Santee incurred higher operating losses in fiscal 1995 as compared
to fiscal 1994, due primarily to increased depreciation expense relating to its
leasehold interest and equipment at the existing dairy plant.
NET INCOME
Net income totaled $16.2 million, $8.4 million and $11.2 million in fiscal
1996, 1995 and 1994, respectively. Higher operating income resulted in the 93%
increase in net income in fiscal 1996 as compared to fiscal 1995. The lower net
income in fiscal 1995 was due to lower operating income, higher losses at Santee
and the higher effective tax rate offset in part by higher interest income.
INFLATION
Hughes' sales for the seven months ended September 29, 1996 reflected
minimal food price inflation or deflation, while sales for the comparable period
in 1995 reflected estimated 1.5% inflation.
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LIQUIDITY AND CAPITAL RESOURCES
QUALITY FOOD CENTERS, INC.
Apart from bank borrowings incurred and Common Stock issued in connection
with the Recapitalization, QFC's principal source of liquidity has been cash
generated from operations. QFC's cash and cash equivalents increased $0.6
million during the 36 weeks ended September 7, 1996 to $11.6 million primarily
due to an increase in cash provided by operations of $36.1 million, $2.7 million
of proceeds received from the sale of real estate and $2.2 million from the
issuance of Common Stock, which more than offset capital expenditures of $25.0
million and a reduction in borrowings under the Company's Current Credit
Facility of $14.5 million. The ratio of current assets to current liabilities at
September 7, 1996 decreased to 0.79 to 1, compared with 1.09 to 1 at December
30, 1995, due primarily to $18.9 million of QFC's long-term debt being
classified as a current liability at September 7, 1996, while none of the
long-term debt was repayable within 12 months as of December 30, 1995. As
discussed below, QFC will refinance its outstanding bank borrowings when it
enters into the New Credit Facility.
QFC's expansion, remodeling and new store activities for the period from
1986 through December 28, 1996 are summarized below (dollars in thousands):
<TABLE>
<CAPTION>
NEW OR
MAJOR ACQUIRED SQUARE FEET CAPITAL
FISCAL YEAR REMODELS(1) RE-REMODELS(2) STORES ADDED EXPENDITURES(3)
- ------------- ----------------- ------------------- ------------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
1986....... 3 -- 1 58,000 $ 3,500
1987....... 2 -- -- 8,000 5,700
1988....... 5 -- -- 16,000 7,600
1989....... 2 -- 2 85,000 9,900
1990....... 1 2 3 107,000 16,600
1991....... 2 1 3 127,000 25,900
1992....... 5 1 3 137,000 26,800
1993....... 3 -- 5 173,000 43,000
1994....... 2 2 7 239,000 28,200
1995....... 5 2 17 609,000 89,100
1996....... 5 8 2 111,000 32,500
--
--- --- ----------- ---------------
35 16 43 1,670,000 $ 288,800
--
--
--- --- ----------- ---------------
--- --- ----------- ---------------
</TABLE>
- ------------------------
(1) Includes replacement stores.
(2) "Re-remodeled" stores are stores that have been remodeled within five years
of a prior remodeling.
(3) Capital expenditures include the purchase of land (including real estate
held for investment), fixtures, equipment and leasehold improvements, as
well as the purchase of leasehold interests, other property rights, goodwill
and covenants not to compete.
After adding 46% to its square footage in 1995, QFC continued to add square
footage in 1996. In March 1996, QFC opened a new 41,000 square foot store in the
Northgate area of Seattle, which replaced a 14,000 square foot store in the same
area. In August 1996, QFC opened a 66,000 square foot University Village Store
in Seattle, replacing a 31,000 square foot store. QFC has also commenced
construction of a new 45,000 square foot Harvard Market Store in Seattle which
is expected to be completed in mid-1997. On October 19, 1996, QFC acquired two
stores located in Seattle from a local independent retailer. The stores are
18,000 and 26,900 square feet, and QFC has commenced a substantial remodeling of
one of such stores and plans to substantially remodel the other store as well.
Additionally, QFC has secured a number of other sites that are still in the
entitlement process or subject to other contingencies. QFC continues to invest
in its existing stores to keep them up-to-date. In addition to the two
replacement stores, as of December 28, 1996, QFC had remodeled three of the
stores acquired from Olson's in 1995 and had completed remodelings of eight
other stores.
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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, were
approximately $32.5 million in fiscal 1996.
QFC paid a cash dividend of $.05 per share in February 1995. QFC has
discontinued the payment of cash dividends on its Common Stock and presently
intends to retain available funds to finance the growth and operations of its
business.
QFC's existing credit facility (the "Current Credit Facility") is a $220
million credit facility entered into in connection with the Recapitalization
which consists of outstanding term loans of $140 million and an $80 million
revolving credit facility. QFC had $145 million of total borrowings outstanding
under the facility, with an interest rate of 1.25% over LIBOR, or 6.66% per
annum, at December 28, 1996. QFC is currently in compliance with all financial
covenants contained in the Current Credit Facility. The Current Credit Facility
will be refinanced and replaced by the New Credit Facility prior to or
concurrently with the closing of the Common Stock Offering and the Notes
Offering.
HUGHES MARKETS, INC.
Hughes' principal source of liquidity has been cash generated from
operations. Hughes' cash and cash equivalents decreased $21.6 million during the
seven months ended September 29, 1996 to $10.5 million, primarily due to
purchases of property and equipment of $30.9 million and net debt payments of
$15.2 million, offset in part by cash generated from operations of $26.0
million. The large capital expenditures during the seven months ended September
29, 1996 primarily related to the new dairy plant being constructed by Santee.
See "Risk Factors--Risks Relating to Santee Dairies" and "Business--Hughes
Markets, Inc.--Santee Dairies." Additional capital expenditures related to the
opening by Hughes of two new 43,945 square foot stores in Alisa Viejo,
California and Placentia, California in June 1996 and July 1996, respectively, a
new 47,400 square foot store in the Valencia area of Southern California in
October 1996 and the construction of a new store in Mission Viejo, California
which is expected to open in March 1997. The ratio of current assets to current
liabilities at September 29, 1996 decreased to 0.89 to 1, as compared to 1.17 to
1 at March 3, 1996, primarily due to the purchase by Santee of land and
construction costs of the new dairy. At September 29, 1996, Hughes had an unused
$32 million revolving credit facility which will be terminated in connection
with the Hughes Acquisition.
The total cost of constructing the new Santee dairy is estimated to be
approximately $100 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. There can be no assurance that the new
dairy will be completed for this amount or that it will be completed and
operational by the dates anticipated. As of January 31, 1997, approximately 40%
of the aggregate budgeted capital expenditures for the construction of the new
dairy had been made. See "Risk Factors--Risks Relating to Santee Dairies."
Presently, negotiations are under way with certain parties to purchase
approximately $80 million of senior secured notes (the "Santee Notes") to be
issued by Santee to finance construction of the new dairy. However, no assurance
can be given that financing for the new dairy will be obtained on acceptable
terms or at all. See "Risk Factors--Risks Relating to Santee Dairies" and
"Description of Certain Indebtedness--Santee Dairies."
Santee is presently party to the Santee Credit Facilities. Santee is
currently in default under certain of the financial covenants relating to the
Santee Credit Facilities and is presently negotiating with its lender to extend
the Santee Credit Facilities and to obtain the appropriate waivers. It is
expected that all the Santee Credit Facilities will remain in place after the
Hughes Acquisition except for the Santee Bridge Loan which will be replaced by
any long-term dairy financing if such financing is obtained. See "Risk
Factors--Risks Relating to Santee Dairies" and "Description of Certain
Indebtedness--Santee Dairies."
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THE COMPANY
It is expected that the New Credit Facility will consist 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 expected to be 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 expected to be 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 expected 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 $25 million each year (subject to certain possible adjustments)
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 (including
guarantees of indebtedness of Santee) in an amount not to exceed $80 million to
finance construction of Santee's new dairy. The Company estimates that, on the
date the New Credit Facility becomes effective, the Company will borrow $250
million under the Term Loan Facility. See "The Acquisitions--Financing." It is
expected that, 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. See "Description of Certain Indebtedness--New Credit
Facility."
The Company has currently budgeted capital expenditures for 1997 of
approximately $62 million in order to remodel existing stores and to acquire and
open new stores. 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 fiscal 1997
or any future period. Capital expenditures may also be increased to the extent
that the Company is required to invest funds in Santee resulting from Santee's
inability to obtain long term financing.
The Company anticipates that cash flow from operations and borrowings under
the New Credit Facility will be sufficient to provide financing for the $62
million of capital expenditures which is currently budgeted through the end 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 long-term 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 addition, the Company has from time to time
issued shares of Common Stock to finance 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.
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BUSINESS
THE INFORMATION CONTAINED HEREIN INCLUDES CERTAIN DEMOGRAPHIC AND ECONOMIC
INFORMATION FOR SOUTHERN CALIFORNIA AND THE SEATTLE/PUGET SOUND REGION, AND ALSO
INCLUDES CERTAIN DATA REGARDING THE U.S. FOOD RETAILING INDUSTRY AND CERTAIN
FOOD RETAILERS. ALTHOUGH QFC HAS OBTAINED SUCH INFORMATION FROM SOURCES IT
BELIEVES ARE RELIABLE, IT HAS NOT INDEPENDENTLY VERIFIED ANY SUCH INFORMATION
AND THERE CAN BE NO ASSURANCE AS TO ITS ACCURACY. IN ADDITION, HISTORICAL
INCREASES IN POPULATION OR JOBS OR DECREASES IN UNEMPLOYMENT IN ANY AREA DO NOT
PURPORT TO BE INDICATIVE OF WHETHER POPULATION, JOBS OR UNEMPLOYMENT WILL
INCREASE OR DECREASE IN THE FUTURE. FURTHER, BECAUSE COMPETITORS OF QFC, HUGHES
AND KUI GENERALLY DO NOT MAKE AVAILABLE INFORMATION REGARDING THEIR SALES IN
THESE SPECIFIC REGIONS, MARKET SHARE INFORMATION IS SUBJECT TO A NUMBER OF
ESTIMATES AND ASSUMPTIONS AND THERE CAN BE NO ASSURANCE AS TO ITS ACCURACY.
GENERAL
QFC is a leading operator of premium supermarkets in the Seattle/Puget Sound
region of the State of Washington having expanded its market share from
approximately 6% of total supermarket sales in 1986 to approximately 20% today,
according to management estimates and calculated on a pro forma basis after
giving affect to the KUI Acquisition and the anticipated divestiture of five KUI
stores. Since commencing operations in 1954, QFC has developed a modern store
base in many prime locations, strong name recognition and a reputation for
superior quality and service. During the ten fiscal years ended December 30,
1995, QFC's EBITDA margin has increased from 4.3% to 8.2% (8.5% for the 36 weeks
ended September 7, 1996) which management attributes primarily to the
development of innovative merchandising strategies, such as increased emphasis
on higher margin specialty departments, combined with enhanced cost controls.
With the acquisition of Hughes, QFC will enter into new markets beyond the
Seattle/Puget Sound area and, with the KUI Acquisition, QFC has continued to
expand within the region as part of its overall strategy of becoming a leading
multi-regional operator of premium supermarkets. Upon consummation of the Hughes
Acquisition, the Company will operate 84 stores in the Seattle/Puget Sound
region as well as 56 "Hughes Family Markets" stores in Southern California. On a
pro forma basis after giving effect to the Acquisitions, the Company would have
had sales of approximately $2 billion and EBITDA of approximately $125 million
for the 52 week period ended September 7, 1996.
Management believes that the Company's QFC stores offer customers superior
value by emphasizing an extensive selection of high quality perishable items,
excellent customer service, convenient store locations and hours, a variety of
specialty departments and competitive prices. QFC stores, which average
approximately 31,000 square feet in size, are open seven days a week, 24 hours a
day, and feature a number of specialty departments such as full service
delicatessens, store seafood departments, bakery departments with
coffee/espresso bars, and floral departments. Many QFC stores also offer natural
food sections, video rentals, fresh juice bars and pharmacies. In addition, QFC
has been an industry leader in leasing space within its stores to branded
specialty food operators, including STARBUCKS COFFEE, CINNABON WORLD FAMOUS
CINNAMON ROLLS and NOAH'S NEW YORK BAGELS, as well as to full service banks such
as SEAFIRST BANK. QFC has recently significantly expanded its selection of
prepared foods and "home meal replacement" items which management believes
appeal to the increasing convenience orientation of consumers. Examples include
complete hot meals which are ready to serve, pre-cooked dinners which are ready
to heat and eat, "Chef's Express" gourmet entrees which are specially prepared
and ready to cook, and "Northwest Sandwich Bars" which feature a variety of
pasta dishes, specialty and made-to-order hot and cold sandwiches, pre-made
salads and self-serve soup and salad bars. Management believes that over the
last five fiscal years, QFC has achieved EBITDA margins well in excess of the
average for the U.S. supermarket industry, which management attributes primarily
to QFC's superior merchandising and operating practices combined with favorable
customer demographics in the Seattle/Puget Sound region.
Upon consummation of the Hughes Acquisition, the Company will own and
operate 56 premium supermarkets under the "Hughes Family Markets" name in
Southern California. Management believes that Hughes, which commenced operations
in 1952 with one store, has developed a strong reputation in
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Southern California for providing high levels of customer service together with
a broad selection of high-quality meat, produce and other perishables.
Management estimates that Hughes' market share among Southern California
supermarkets (excluding San Diego county) was approximately 5% for 1995. Hughes'
stores average approximately 37,000 square feet in size and are generally
located near desirable residential areas. Management believes that Hughes has
among the most modern store bases of any supermarket chain in Southern
California (defined to exclude San Diego county) due in part to its ongoing
store remodeling program. Hughes supplies the majority of its stores' inventory
from its own centrally located 600,000 square foot warehousing and distribution
facility built in 1993. Hughes also owns a 50% interest in Santee, one of the
largest dairy plants in California, which provides dairy and other products to
Hughes, as well as to certain other third parties, under the well-known
"Knudsen" and other labels.
The KUI Acquisition, which closed on February 14, 1997, provides the Company
with desirable store locations primarily in the southern Puget Sound region and
the Olympic Peninsula of the State of Washington, areas in which QFC currently
has a limited presence. Management currently anticipates that it will retain 20
of the 25 stores acquired from KUI. Most of such stores will be converted to the
QFC name and format and remodeled in order to implement QFC's merchandising and
operating practices, although it is expected that the Company (through KUI) may
continue to operate certain of these stores under KUI's current "Stock Market"
name and format. In addition, management believes that the KUI Acquisition
provides the Company with additional critical mass in the Seattle/Puget Sound
region which should improve purchasing and distribution and help create
economies of scale. After giving effect to the KUI Acquisition, including the
anticipated divesture of five KUI stores, management estimates that QFC's market
share among supermarkets in the Seattle/Puget Sound region is approximately 20%
today. See "The Acquisitions."
GROWTH STRATEGY
The Company's strategic objective is to become a leading multi-regional
operator of premium supermarkets in order to continue to achieve its goal of
controlled and profitable growth. To this end, the Company plans to capitalize
on its acquisition, merchandising and operating expertise to: (i) increase sales
and enhance margins in existing and newly acquired stores, (ii) realize the
benefits of the Hughes and KUI Acquisitions, (iii) acquire and build new stores
in its existing and contiguous markets and (iv) acquire supermarket chains in
attractive new markets. In order to facilitate this phase of the Company's
development, the Company has hired a new chief executive officer and senior vice
president for corporate development to pursue and integrate acquisitions at a
holding company level, thus allowing current senior management to remain focused
on existing operations. See "The Proposed Reorganization" and "Management." See
"Risk Factors--Risks Relating to Acquisition Strategy" for a discussion of
certain uncertainties pertaining to the Company's strategy.
INCREASE SALES AND ENHANCE MARGINS IN EXISTING AND NEWLY ACQUIRED STORES.
One of the Company's top priorities is to increase sales and enhance margins
in existing and newly acquired stores by: (i) emphasizing higher margin
specialty and convenience items, (ii) expanding sales of proprietary brands
(private label) and (iii) maintaining its high quality store base.
- EMPHASIZE HIGHER MARGIN SPECIALTY AND CONVENIENCE ITEMS. The Company
intends to further develop and implement specialty and
convenience-oriented departments at its stores, which management believes
are important tools to enhance margins, increase foot traffic and build
customer loyalty. QFC has been an industry leader in the development of
higher margin products and services, such as prepared foods and home meal
replacement items, which are geared toward the increasing convenience
orientation of consumers. Management believes that the increase in QFC's
EBITDA margins over the past ten fiscal years has been due in part to
sales of items within these departments, as well as to sales of its
seafood, delicatessen, bakery, floral and other specialty products.
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- EXPAND SALES OF PROPRIETARY BRANDS. QFC recently adopted a program
designed to increase its sales of proprietary brands, which typically
carry higher margins than comparable branded products and at the same time
help promote customer loyalty. After a long-term study of operating
practices both in the U.S. and abroad, QFC developed a three-tier
proprietary brands philosophy which is approximately two-thirds
implemented. As a result of this effort, QFC has increased the percentage
of proprietary brand sales from less than 3% of grocery sales at the
beginning of fiscal 1996 to approximately 8.5% of grocery sales at the end
of fiscal 1996. This percentage is well below the estimated 1995
supermarket industry average, which management believes was approximately
15% of sales, thus providing a significant opportunity for growth of
proprietary brand sales.
- MAINTAIN ITS HIGH QUALITY STORE BASE. The Company believes that QFC and
Hughes stores are among the most modern and well-maintained in their
respective regions, due in part to their respective remodeling programs.
During the five fiscal years ended December 28, 1996, QFC remodeled or
"re-remodeled" 31 stores, of which 16 were acquired stores which were
remodeled as part of their conversion to the QFC format. Of the 20 stores
expected to be retained in the KUI Acquisition, 13 are presently expected
to be significantly remodeled to facilitate the implementation of QFC's
merchandising and operating practices prior to their conversion to the QFC
name and format. While management believes that the Hughes stores are
generally in good condition, the Company plans to selectively remodel
certain Hughes stores in order to enhance the presentation and
merchandising of meat, seafood, delicatessen items and other perishables
and to add or enhance full-service and leased specialty departments.
REALIZE THE BENEFITS OF THE HUGHES AND KUI ACQUISITIONS.
Management believes that the acquisition of Hughes and KUI will provide the
Company with a number of benefits, including the following:
- CROSS-FERTILIZATION OF OPERATING CAPABILITIES. Management believes that
significant opportunities exist to improve results of operations at
acquired stores through the implementation of QFC's merchandising and
operating practices. For example, management believes that the Hughes
stores will benefit from the adoption of certain merchandising practices
successfully implemented at QFC stores, including practices relating to
the development of higher margin specialty and convenience oriented
departments. The Company will also seek to expand the use of proprietary
brands at Hughes by drawing on QFC's own recently developed proprietary
brands program. Similarly, the Company expects its QFC stores to benefit
from the experience of Hughes' management in areas such as purchasing,
distribution and category management.
- PURCHASING AND DISTRIBUTION-RELATED BENEFITS. Management anticipates that
certain benefits will accrue to the Company in the area of purchasing and
distribution as a result of both the Hughes and KUI Acquisitions. For
example, as a result of the KUI Acquisition, management believes that the
Company's larger size in the Seattle/Puget Sound region provides the
Company increased flexibility with regard to supply and distribution
options and should enhance its ability to negotiate lower prices from its
suppliers. Management also expects that the Company's Seattle/Puget Sound
operations will benefit from Hughes' experience in operating its own
warehouse and distribution center. Further, to the extent that the Company
adds to its store base in Southern California, it is expected that it will
benefit from excess capacity at the Hughes distribution center, which
management estimates is currently operating at approximately 50% of
capacity.
- COST SAVINGS AND VOLUME EFFICIENCIES. The Company expects to achieve cost
savings from the elimination of redundant administrative staff, the
consolidation of management information systems and a decreased reliance
on certain outside services as a result of the Acquisitions. In addition,
the Company expects to benefit from savings in the areas of store
supplies, store maintenance, and
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risk management, among other areas, as a result of increased purchasing
power and volume and operating efficiencies.
ACQUIRE AND BUILD NEW STORES IN ITS EXISTING AND CONTIGUOUS MARKETS.
The Company plans to continue to acquire, and to a lesser extent build, new
stores in its existing and contiguous markets. Management believes that
in-market acquisitions provide an efficient way for the Company to increase
sales in its markets without the resulting increase in overall supermarket
capacity caused by the construction of additional stores. During the past six
years, QFC has acquired and successfully integrated 30 stores from ten operators
in the Seattle/Puget Sound region, including 12 stores acquired from Olson's
Food Stores in 1995. The KUI Acquisition represents a continuation of this
strategy of expanding QFC's presence in its existing and contiguous markets.
Over the last several years the Seattle/ Puget Sound region has been one of the
fastest growing areas in the United States in terms of population, and the KUI
Acquisition not only expands the Company's presence in the region but also
broadens the Company's coverage of the southern portion of the region and the
Olympic Peninsula. See "--Market Overview--Seattle/Puget Sound." This strategy
also encompasses expanding into the northern part of the Puget Sound region as
well as into contiguous areas such as eastern Washington and Portland, Oregon.
The Company will seek to implement this strategy in its new Southern California
market as well.
ACQUIRE SUPERMARKET CHAINS IN ATTRACTIVE NEW MARKETS.
The Company will continue to actively seek growth opportunities outside its
existing and contiguous markets by pursuing the acquisition of supermarket
chains which are well-known within their respective markets, have strong growth
potential and are located in geographic areas exhibiting favorable economic and
demographic conditions. For example, Hughes has a reputation for high quality
products and customer service with stores located in Southern California, an
area which the Company believes has recently begun to exhibit growth in jobs and
population and a decrease in unemployment. See "--Market Overview--Southern
California." The acquisition of Hughes is the first step in the Company's plans
to become a leading multi-regional operator of premium supermarkets. Management
believes that there are a number of attractive acquisition opportunities in
desirable growth areas, and that these opportunities are attributable in part to
the fragmented nature of a large portion of the domestic supermarket industry.
INDUSTRY OVERVIEW
The food retailing industry in the United States includes national and
regional supermarket chains, independent and specialty grocers, traditional
convenience food stores and newer "alternative format" food stores, including
warehouse club stores, deep discount food operators and supercenters. Management
believes that a large portion of the U.S. supermarket industry is highly
fragmented. In particular, according to industry reports, the top ten operators
of supermarkets (excluding convenience and grocery stores with annual sales of
less than $2 million and also excluding warehouse stores, club stores, deep food
discounters and supercenters) accounted for approximately 30% of the
approximately $312 billion of 1995 domestic supermarket sales, while no
supermarket operator outside of the top five accounted for more than 3% of such
sales. According to industry reports, approximately 150 supermarkets had sales
of $250 million or higher in 1995. Recently, the food retailing industry has
been experiencing consolidation as larger supermarket chains acquire smaller
independent competitors within their markets as well as supermarket chains in
different geographic markets. According to the PROGRESSIVE GROCER ANNUAL REPORT
published in April 1996, high-volume chain supermarkets accounted for 77% of
1995 supermarket sales, as compared to only 62% in 1975. Management believes
that the supermarket industry will continue to consolidate and that the Company
is well positioned to take advantage of this consolidation through the
acquisition of competitors within the Seattle/Puget Sound region and Southern
California, as well as supermarket chains in other geographic markets considered
attractive by management.
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Management believes that, in recent years, the trend toward increased
convenience has led to an increase in eating away from home and the purchase of
prepared meals for home consumption. According to the U.S. Department of
Commerce, retail sales for "eating and drinking" establishments increased by
6.2% per annum from 1986 to 1995, significantly higher than the 3.7% annual
growth experienced by "food stores" during the same period. In response to this
trend, supermarkets have expanded their frozen food selections, full service
specialty departments such as delicatessens, and home meal replacement products,
each of which provide convenience-oriented consumers with an alternative to
restaurants and fast food establishments. Home meal replacement items vary by
supermarket chain but can include hot meals which are ready to serve, pre-cooked
dinners which are ready to re-heat, pre-seasoned meals which must be cooked,
pre-made or custom sandwiches, sushi, pre-made salads, soups and self-serve
salad bars. Management believes that QFC is a leader in terms of the selection
and quality of the meal replacement products it offers and that these higher
margin products promote increased store traffic and customer loyalty, as well as
higher sales and margins.
MARKET OVERVIEW
SEATTLE/PUGET SOUND
According to data compiled by Conway Pedersen Economics, Inc. ("Conway
Pedersen"), an economic consulting firm, the Seattle/Puget Sound region has
expanded more rapidly than the nation over the past ten years. According to
Conway Pedersen, the population of the region has grown 10.3% since 1990 to an
estimated 3.1 million by 1996 and is forecasted to continue growing
approximately 2% per annum through 1998. In addition, according to Conway
Pedersen, the area had one of the highest per capita household incomes in the
United States in 1995 and was recently chosen the "number one" place to live and
work by FORTUNE magazine. According to Conway Pedersen, job growth for 1996 is
expected to exceed 3.0% as Boeing, the area's largest employer, has renewed
hiring plans in response to the recent increase in demand for commercial
aircraft. This compares to job growth as reported by Conway Pedersen of 1.9% in
1995 and forecasted future growth exceeding 3.0% per annum through the year
1998. According to Conway Pedersen, unemployment has also declined to its lowest
level in five years, which was expected to reach 4.8% by the end of 1996, as
compared to approximately 6.7% in 1992. In addition to the aerospace industry,
key industries include computer software, bio-technology, financial services,
healthcare service and international trade.
SOUTHERN CALIFORNIA
According to data compiled by the UCLA Business Forecasting Project (the
"UCLA Forecast"), Southern California (defined to include the counties of Los
Angeles, Orange, Riverside, San Bernardino, San Diego, Santa Barbara and
Ventura) had an estimated 1996 population of more than 18.8 million people or
more than 50% of the total population of California. According to the UCLA
Forecast, job growth in the region was approximately 2.3% for the 12 months
ended October 31, 1996. In addition, the UCLA Forecast indicates that, at
October 31, 1996, the unemployment rate in California was approximately 7.3%,
down from approximately 9.4% in 1993, and is forecasted to continue declining to
below 6.0% by 1998. In addition to aerospace and defense, key industries include
entertainment, financial services, healthcare services, international trade and
tourism. According to Regional Financial Associates, Inc. ("RFA"), an economic
consulting firm, the region's motion picture industry accounted for nearly
130,000 jobs as of mid-1996, more than double the number employed in the
industry in mid-1986. Tourism is also an important source of jobs for the region
with over 22 million overnight visitors having spent an estimated $10 billion in
1995 according to RFA. Recently, the most rapidly growing areas in Southern
California in terms of population and job growth have included those surrounding
Los Angeles, such as Riverside, San Bernardino, Orange and Ventura counties
according to RFA.
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QUALITY FOOD CENTERS, INC.
Unless otherwise expressly stated or the context otherwise requires, the
discussion set forth under "Business--Quality Food Centers, Inc." relates solely
to the stores owned and the business conducted by QFC prior to the Acquisitions,
and does not include stores owned and businesses conducted by Hughes or KUI.
MERCHANDISING
QFC's merchandising goals are to attract new customers, become the primary
source for its customers' weekly grocery needs and capture a greater portion of
their supermarket spending. In order to achieve these goals, QFC's merchandising
strategy emphasizes: (i) superior customer service, (ii) a wide variety of high
quality meat, seafood, produce and other perishables, (iii) high quality
convenience-oriented specialty departments and services and (iv) a broad
assortment of higher-margin proprietary brands. Management believes that QFC's
strengths in merchandising, combined with its competitive pricing, have earned
QFC stores a reputation for providing superior "value" to their customers and
have resulted in a loyal customer base.
SUPERIOR CUSTOMER SERVICE. Management believes that QFC's commitment to
superior customer service distinguishes it from much of its competition. In
addition to its stores remaining open 24 hours a day, seven days a week, QFC's
operating practices have been designed to emphasize customer convenience and
satisfaction. Employees typically attend department specific training classes at
QFC's training center located at its headquarters and also generally receive
follow-up in-store training. QFC employees are trained to actively address
customer needs by asking shoppers whether they need help and then by locating,
recommending and selecting merchandise for their customers. For example,
employees in QFC's meat and seafood departments, in addition to offering
specialized service in those areas, are trained to assist customers with cooking
instructions and recipes and direct them to employees in other departments, such
as wine specialists found in selected stores, for additional needs. QFC product
preparation areas in these departments are open to promote such interaction with
customers. QFC also emphasizes a broad selection of product choices and brands
within any given food category in an effort to foster "one-stop shopping." Each
store's staff is encouraged to be friendly, which often results in employees
knowing their regular customers by name. QFC's flagship University Village store
in Seattle offers a child center with trained child-care personnel. Each store's
checkout stands are custom designed to speed the checkout process and
incorporate computerized scanning and other systems to aid in the checkout
process. QFC also accepts credit and debit cards for the convenience of its
customers, checkout clerks unload items from the cart to the checkout stand and
courtesy clerks are available to assist shoppers with their grocery bags after
checkout.
WIDE VARIETY OF HIGH QUALITY MEAT, SEAFOOD, PRODUCE AND OTHER
PERISHABLES. Offering a wide variety of consistently high quality meat, seafood
and produce to its customers is a fundamental tenet of QFC's merchandising
strategy. Management believes that its reputation for providing among the
freshest and widest varieties of these major groups of perishables, displayed in
a clean and visually appealing presentation, is a major attraction for its
customers. QFC provides carefully trimmed "choice" USDA beef, high quality pork
and Washington-grown poultry. QFC has also recently introduced a high-end
branded beef known as "premier choice" as well as kosher meats and poultry in
selected stores prepared at QFC's USDA-approved processing facility. Management
believes that its seafood departments have a reputation for providing among the
finest quality and widest selection of seafood and shellfish in the
Seattle/Puget Sound area. As part of this emphasis on quality, QFC has full-time
employees stationed in its primary seafood supplier's facility to pre-screen
seafood products before they are shipped to QFC. QFC's in-store produce
employees are trained to eliminate items that do not meet QFC standards and to
carefully trim, hand stack and attend to the display and presentation of the
produce. In an effort to provide specialty salads and other products of
consistently high quality in every QFC deli department, many deli items are
prepared in QFC's central commissary which has improved quality, consistency and
shelf life. Instead of
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baking in each store, several bakeries in the Seattle/Puget Sound area deliver
fresh baked goods daily to QFC's stores, which management believes allows QFC to
sell higher quality and a wider variety of baked goods with greater product
consistency than if these products were baked on-site.
HIGH QUALITY CONVENIENCE-ORIENTED SPECIALTY DEPARTMENTS AND SERVICES. QFC
provides a broad variety of products and services through its specialty
departments which have been designed to appeal to the increasing convenience
orientation of supermarket customers. For example, in the past year, QFC has
placed significant emphasis on prepared foods and "home meal replacement" items.
Such items include complete hot meals, such as prime rib, london broil and
salmon dinners, which are ready to serve, pre-cooked dinners which are ready to
heat and eat, and "Chef's Express" gourmet entrees which are specially prepared
and ready to cook. QFC stores also offer "grab and go" salads, "Northwest
Sandwich Bars" which feature hot pasta dishes, soups and specialty and
made-to-order hot and cold sandwiches and coffee and espresso bars. Certain
stores also offer fresh juice bars, natural foods departments and sushi
selections. All stores offer photo-processing, floral departments and automated
bank-teller machines for added convenience, while video rentals and pharmacies
are offered at some of QFC's stores. In addition, QFC currently leases or
sub-leases space at a number of its stores to STARBUCKS COFFEE, CINNABON WORLD
FAMOUS CINNAMON ROLLS and NOAH'S NEW YORK BAGELS, as well as to full service
banks such as SEAFIRST BANK.
BROAD ASSORTMENT OF HIGHER-MARGIN PROPRIETARY BRANDS. QFC has recently
developed a comprehensive three-tier proprietary brands program, which includes
"SIGNATURE" brands, "ENDORSED" brands, and "PRICE FIGHTER" brands. This program,
which was developed to help improve sales and margins and build customer
loyalty, is almost fully implemented, with approximately two-thirds of the total
number of expected store brand SKUs having been introduced. QFC's "SIGNATURE"
brand products include premium quality items produced expressly for QFC and sold
under a variety of names, such as CASTLEBURY ice cream and yogurt and Northern
Cove chowders, as well as other local brands such as CUCINA! CUCINA! Italian
foods for which QFC is the only supermarket distributor in the Seattle/Puget
Sound region. The second tier, called "ENDORSED" brands includes a variety of
high quality items, such as QFC's BAKER VALLEY FARMS dairy brand, that bear the
QFC "satisfaction guaranteed" seal of endorsement. The "PRICE FIGHTER" brands
are marketed under the Heritage Farm label and are designed to replace items
previously provided by QFC's wholesalers with a wide selection of higher quality
products that are positioned as national brand equivalents at lower prices.
QFC's proprietary brands program currently includes approximately 700 stock
keeping units ("SKUs"), many of which are recent additions. QFC's proprietary
brands business for the 16 weeks ended December 28, 1996 accounted for
approximately 8.5% of grocery sales whereas, according to industry reports, the
estimated 1995 supermarket industry average was approximately 15%, thus
providing significant opportunity for the continued growth of store brand sales.
STORE BASE AND DEVELOPMENT
Management believes that QFC has developed a modern and well-maintained base
of stores in many prime locations in the Seattle/Puget Sound area. QFC currently
operates 64 supermarkets, generally in or nearby desirable residential areas.
Management currently anticipates that it will retain approximately 20 of the
25 stores acquired in the KUI Acquisition and sell or otherwise divest the
others. Of the 20 KUI stores expected to be retained, 13 are expected to be
converted to the QFC name and format and thus significantly remodeled as part of
the Company's plan to implement QFC's merchandising and operating practices in
its new stores. It is presently expected that the Company will continue to
operate the remaining stores under KUI's current "Stock Market" name and format.
During the five fiscal years ended December 28, 1996, QFC invested
approximately $220 million in capital expenditures, which have been primarily
allocated toward acquiring and building new stores and expanding and remodeling
or "re-remodeling" existing stores. During such period, QFC acquired or opened
34 new stores and remodeled or "re-remodeled" 31 existing stores. QFC remains
committed to
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keeping its existing stores in top condition with the latest customer
conveniences, information systems, merchandise, departments and decor.
While most of its newer stores are larger and while QFC expects the average
size of its stores to grow as stores are remodeled and expanded, QFC intends to
remain flexible in terms of the size of its new and acquired stores. At the end
of 1996, the total square footage of all 64 stores was approximately 2,100,000
square feet with an average store size of approximately 31,000 square feet, and
a range in size from 14,000 to 66,000 square feet. QFC increased its total
square footage by 22%, 46% and 6% in fiscal 1994, 1995 and 1996, respectively.
The following table sets forth certain information with respect to store size.
<TABLE>
<CAPTION>
NUMBER OF STORES AT
DECEMBER 28, 1996
-----------------------
<S> <C>
Store Size:
Less than 20,000 square feet.......................................... 9
Between 20,000 and 30,000 square feet................................. 21
Between 30,000 and 40,000 square feet................................. 23
Between 40,000 and 50,000 square feet................................. 8
Over 50,000 square feet............................................... 3
--
64
</TABLE>
The following table sets forth additional information concerning QFC stores
for the periods indicated:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
--------------------------------------------------------------------------
DECEMBER 26, DECEMBER 25, DECEMBER 31, DECEMBER 30,
1992 1993 1994 1995
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
TOTAL STORES:
Beginning of period................... 30 33 38 45
Newly constructed................... 1 3 1 1
Acquired............................ 2 2 6 16
Closed.............................. 0 0 0 0
-- -- -- --
End of period......................... 33 38 45 62
REMODELS................................ 5 3 2 5
RE-REMODELS(1).......................... 1 0 2 2
<CAPTION>
DECEMBER 28,
1996
-----------------
<S> <C>
TOTAL STORES:
Beginning of period................... 62
Newly constructed................... 0
Acquired............................ 2
Closed.............................. 0
--
End of period......................... 64
REMODELS................................ 5
RE-REMODELS(1).......................... 8
</TABLE>
- ------------------------
(1) "Re-remodeled" stores are stores that have been remodeled within five years
of a prior remodeling.
The Company's plans to expand and remodel its existing stores and to add new
stores are reviewed continually and are subject to change. QFC has been highly
selective in acquiring store sites and attempts to take advantage of market
research and its extensive knowledge of the Seattle/Puget Sound region in
evaluating opportunities. In conducting market research for store sites, QFC
typically evaluates population shifts, demographic conditions, zoning changes,
traffic patterns, new construction and the proximity of competitors' stores in
an effort to determine a future store's sales potential. The Company's ability
to expand and remodel existing stores and to open new stores, however, is
subject to many factors, including successful negotiation of new leases or
amendments to existing leases, successful site acquisition and the availability
of financing on acceptable terms, and may be limited by zoning, environmental
and other governmental regulations. See "Risk Factors--Risks Relating to
Acquisition Strategy."
PURCHASING AND DISTRIBUTION
QFC does not maintain independent distribution facilities and instead
purchases the majority of its groceries, meat and some seafood, deli and produce
from wholesale suppliers. QFC's merchandise is ordered on a store-by-store
basis, although product selection is typically approved and monitored by a
central buying group consisting of merchandise managers for various
classifications of products. The central buying group also responds to customer
requests and input from store managers regarding new products and merchandising
ideas using category management principles and allocates shelf space to
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<PAGE>
products with the assistance of QFC's schematic department which uses
state-of-the-art shelf allocation software to help determine the efficient shelf
layouts.
QFC's major wholesale supplier is West Coast Grocery Company ("West Coast"),
a subsidiary of Super Valu Stores, Inc. QFC purchased approximately $208.6
million and $148.9 million of products from West Coast during fiscal 1995 and
during the 36 weeks ended September 7, 1996, respectively, accounting for 37.9%
and 36.3% of QFC's cost of sales and related occupancy expense during such
periods, respectively. Beginning with the Olson's Merger in March 1995, QFC
began using Associated Grocers ("Associated") as its major wholesale supplier
for the 12 stores that were previously operated by Olson's. Associated is a
cooperative wholesale supplier located in Seattle, Washington. QFC purchased
approximately $44.5 million and $40.1 million of products (before rebates) from
Associated during fiscal 1995 and during the 36 weeks ended September 7, 1996,
respectively, accounting for 7.8% and 9.8% of QFC's cost of sales and related
occupancy expense during such periods, respectively. Currently, 49 of QFC's
stores buy from West Coast and 15 from Associated. In addition, certain
products, such as beer, wine, soda and certain snack foods, are purchased from
other manufacturers or distributors which, as do West Coast and Associated,
deliver directly to QFC's stores. QFC also maintains a central commissary where
certain items, such as hot and cold salads, sauces and dressings, and certain
"Chef's Express" ingredients, are prepared primarily for QFC's deli departments.
In addition, kosher meat and poultry are prepared in QFC's USDA-approved
processing facility. QFC also periodically purchases higher turnover products
directly from the manufacturer that would otherwise be supplied by West Coast or
Associated.
The stores acquired in the KUI Acquisition currently purchase products from
Associated. According to information made publicly available by Associated, KUI
is currently Associated's largest customer, having accounted for approximately
19% of Associated's sales for Associated's fiscal year ended September 30, 1996.
As a result of the KUI Acquisition, QFC owns 22% of the non-voting equity of
Associated.
MANAGEMENT INFORMATION SYSTEMS
Although QFC already makes extensive use of management information systems,
management remains committed to the further development and use of information
systems as a tool to enhance results of operations. QFC continues the migration
from its mainframe host computer to a client-server based architecture to meet
its long-term needs and convert to open systems technology. Management expects
that QFC's new item and category management system (which tracks and analyzes
sales data), coupled with expanded point-of-sale capabilities and a new pricing
system under development, will enable it to improve its operations through
category management and by improving pricing and promotional strategies.
In 1993, QFC installed personal computer-based point-of-sale hardware and
software in every checkout lane of every store. QFC utilizes a private voice and
data network and an electronic payment system that processes customer purchases
by debit and credit cards. In 1996, QFC implemented a check authorization
system, which is integrated into QFC's point-of-sale hardware and software. QFC
also has a direct store delivery system for non-perishable deliveries, which
integrates the receipt of goods at the store with accounting and merchandising
at QFC's main office. This integrated system offers QFC timely information and
greater efficiency and control over product receipts, merchandising and accounts
payable functions. QFC processes product orders, direct store deliveries and
store accounting functions on personal computers in each store which are
integrated with centralized corporate systems. In addition, custom software and
laser printers are used to create shelf tags, attractive signs and customized
promotional materials on-site at each store. Electronic Data Interchange ("EDI")
is used extensively to transmit various business documents to and from QFC's
suppliers. QFC also installed a company-wide electronic mail system in 1996.
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<PAGE>
Management anticipates that over time, each of the KUI stores to be retained
by the Company will be converted to QFC's management information system.
MARKETING AND PROMOTION
QFC advertises primarily through newspapers, television and radio, as well
as billboards and busboards. QFC also promotes products through the use of
direct mail circulars, which it can produce in-house, and which are distributed
every Wednesday, as well as through in-store "demonstrations," tastings and
hand-outs. QFC's television and radio ads are primarily image based, promoting
the quality of its products, employees and customer service, while its print
advertising is primarily price/item-based.
QFC also promotes its products through special seasonal promotions during
the periods leading up to such holidays as Easter, Thanksgiving and Christmas.
In addition, QFC typically advertises the opening of new stores and the
re-opening of major remodeled stores and often conducts special promotions and
events in connection with these openings and re-openings.
QFC also has an in-house product demonstrations staff, which provides
product demonstrations and free samples in its stores. QFC is actively involved
in the community which it serves in order to be a good corporate citizen as well
as to build customer loyalty, and plays a role in many local events.
For the 36 weeks ended September 7, 1996, QFC spent approximately 55% of its
marketing budget on newsprint advertisements such as newspaper inserts and
circulars, approximately 27% for television and radio advertising and
approximately 15% on special events such as new store opening promotions. The
remainder of the budget was used for direct mail for special promotions.
COMPETITION
The retail supermarket business is highly competitive. QFC and KUI compete
primarily with national and regional supermarket chains and other food
retailers, principally Safeway, Albertson's and Fred Meyer, and with smaller
chains and independent stores as well as wholesale club formats, such as Price/
Costco, and specialty and convenience food stores.
The principal areas of competition include store location; product selection
and quality; convenience and cleanliness; employee friendliness and service;
price; and management information enabling timely product selection, pricing and
promotion decisions. QFC seeks to address each of these factors, emphasizing
superior service, high quality perishables, the use of technology, and favorable
store locations. Competitive pricing is implemented by reviewing competitors'
prices on a regular basis through observation and independent surveys and
adjusting prices as management deems appropriate. Certain of these strategies
are also used by QFC's competitors, some of which have substantially greater
financial and other resources than QFC. The Company will seek to address these
factors in a similar fashion at the KUI stores it intends to retain.
During the fourth quarter of 1994 and throughout 1995, QFC experienced an
unusually large number of new store openings or store remodelings by its
competitors near its existing stores, which resulted in reduced sales in certain
of QFC's stores. Fewer such openings occurred during 1996. See "Risk Factors--
Competition" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
EMPLOYEES AND LABOR RELATIONS
QFC had approximately 4,400 employees at the end of fiscal 1996. Of these,
approximately 4,100 were covered by an aggregate of seven collective bargaining
agreements which expire in the period from May 3, 1998 to December 1, 1998.
QFC's most significant union is the United Food and Commercial Workers Union
Local No. 1105, of which 2,900 QFC employees are members; this contract expires
on May 3, 1998. QFC has not had a work stoppage in over 20 years and believes
its labor relations are good. However,
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there can be no assurance that work stoppages or other labor matters will not
adversely effect the Company in the future. See "Risk Factors--Labor Relations."
KUI had approximately 1,700 employees at the end of fiscal 1996. Of these,
approximately 1,500 were covered by an aggregate of 14 collective bargaining
agreements which expire in the period from May 31, 1997 to June 9, 1999. KUI's
largest union is the United Food and Commercial Workers Union Local No. 367, of
which 900 KUI employees are currently members under contracts which expire from
May 3, 1998 to November 29, 1998. QFC believes that KUI has had a good
relationship with its employees. However, there can be no assurance that work
stoppages or other labor matters relating to the stores acquired from KUI will
not adversely affect the Company in the future. See "Risk Factors--Labor
Relations."
The Company believes that a substantial majority of the employees of
supermarket chains in the Seattle/Puget Sound region, including QFC's and KUI's,
are members of these collective bargaining units.
PROPERTIES
At December 28, 1996, QFC leased 59 of its 64 supermarkets and its
administrative facilities under non-cancelable operating leases with various
terms expiring through December 2053, including renewal periods. The average
remaining term of QFC's leases (including all renewal options) is approximately
31 years, with none of these leases subject to expiration within five years. Of
the 20 stores expected to be retained in the KUI Acquisition, 18 will be leased
and two will be owned. The average remaining term of the leases of these 18 KUI
stores (including renewal options) is approximately 32 years and only one of
such leases (expiring in April 1997) is subject to expiration within five years.
QFC typically renegotiates a store lease prior to committing to a major
store remodel. The leases generally provide for minimum rental amounts, with
contingent rental payments based on a percentage of gross sales, plus real
estate tax payments and reimbursement of certain common-area maintenance costs.
QFC owns most of the equipment, furniture and fixtures at its retail and
administrative locations and has made leasehold improvements at most locations.
QFC may seek to increase its ownership of future store locations in
instances where management believes that it can better control occupancy
expenses through ownership. At December 28, 1996, QFC owned the real estate at
five of its store facilities in operation, one of which was part of a small
shopping center owned by QFC. The real estate operations of this center are
currently not material to QFC's results of operations. During 1995, QFC sold one
of the shopping centers it previously operated, in 1996 it sold another, and the
one remaining center is currently for sale. QFC retained ownership of its store
buildings and pads in the centers that were sold, and intends to do so in the
remaining center to be sold as well. There are no mortgages on QFC's owned
stores.
QFC has entered into option agreements for, and purchased, real estate
within its existing Seattle/ Puget Sound market areas where it plans to locate
stores in the future. Certain of these store locations are in the entitlement
process or subject to other contingencies.
SEASONALITY
No material portion of QFC's or KUI's business is affected by seasonal
fluctuations, except that sales are generally stronger surrounding holidays,
especially from Thanksgiving through New Year's Day. In addition, QFC's fiscal
quarters consist of three 12-week quarters and a 16-week fourth quarter.
However, 1994 was a 53-week fiscal year, with a 17-week fourth quarter.
ENVIRONMENTAL MATTERS
QFC and KUI are subject to federal, state and local laws, regulations and
ordinances that (i) govern activities or operations that may have adverse
environmental effects, such as discharges to air and water, as well as handling
and disposal practices for solid and hazardous wastes and (ii) impose liability
for the costs
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of cleaning up, and certain damages resulting from, sites of past spills,
disposal or other releases of hazardous materials (together, "Environmental
Laws"). In particular, under applicable Environmental Laws, QFC and KUI may be
responsible for remediation of environmental conditions and may be subject to
associated liabilities (including liabilities resulting from lawsuits brought by
private litigants) relating to their stores and the land on which their stores
are situated, regardless of whether QFC or KUI lease or own the stores or land
in question and regardless of whether such environmental conditions were created
by QFC or KUI or by a prior owner or tenant.
QFC believes that it currently conducts its business, and in the past has
operated its business, in substantial compliance with applicable Environmental
Laws and regulations. In addition, compliance with federal, state and local laws
enacted for protection of the environment has had no material effect on QFC.
However, there can be no assurance that environmental conditions relating to
prior, existing or future QFC or KUI stores or store sites will not have a
material adverse effect on the Company. See "Risk Factors--Environmental
Matters."
In connection with the KUI Acquisition, QFC reviewed existing reports and
retained environmental consultants to conduct certain investigations of the
operations of KUI. Phase I environmental site assessments were conducted on the
KUI stores and store sites. These Phase I environmental site assessments did not
reveal any environmental matter that is likely to have a material adverse effect
on the Company.
LEGAL PROCEEDINGS
The Company is currently involved in a number of legal proceedings which
have arisen in the ordinary course of business. Management believes these
proceedings will not, in the aggregate, have a material adverse effect on the
Company. However, the Company is unable to predict whether the outcome of such
actions may or may not have a material adverse effect on the Company's results
of operations in a particular future period as the timing and amount of any
resolution of such actions and their relationship to future results of
operations are not known.
HUGHES MARKETS, INC.
MERCHANDISING
Hughes' merchandising strategy emphasizes: (i) superior customer service,
(ii) a wide selection of high quality products, (iii) competitive pricing and
promotions and (iv) the development of proprietary brands.
SUPERIOR CUSTOMER SERVICE. The foundation of Hughes' merchandising strategy
is its commitment to providing superior service and convenience. Each Hughes
store monitors customer satisfaction in an effort to respond to its customers'
shopping needs. Each store's checkout lanes are supplied with postage-paid
comment cards which are reviewed and typically answered personally in writing or
by phone. Hughes also employs an outside firm to monitor customer service and
relations. Hughes' employees typically undergo in-store training which stresses
customer service and relations, such as offering to specially order a particular
product for a customer in the event it is not available in a store. As part of
this commitment to its customers, Hughes stores are generally open 24 hours a
day, seven days a week, and offer a wide variety of services, departments and
products. All Hughes stores offer photo-processing services and automated teller
machines. 50 Hughes stores have on-site bakeries, 40 of which supply all of
their own baked goods, 50 stores have full-service delicatessens, 52 stores have
full service fish departments and the majority of the stores offer floral
departments and fresh salad bars. 21 Hughes stores have in-store banking
services.
WIDE SELECTION OF HIGH QUALITY PRODUCTS. Hughes has built a reputation for
offering a wide variety of consistently high quality products, with a focus on
perishables such as meat and produce. Hughes stores carry only "USDA Choice"
beef and American lamb and veal and other high quality pork and poultry items,
while its full service seafood departments feature U.S. Department of Commerce
inspected seafood
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items. Hughes also strives to be a leader in providing fresh produce to its
customers and today enjoys a reputation for offering a wide variety of high
quality produce. For example, Hughes has state-of-the-art, pressurized banana
ripening rooms at its Irwindale, California distribution facility which help
ensure greater consistency of color, and provide a shorter ripening cycle and
longer shelf-life than conventional ripening rooms. In the past year, Hughes has
also placed significant emphasis on prepared specialty foods. Under the label
"Home Meal Solutions," Hughes stores sell complete meals, such as pork
spareribs, lasagna, and whole rotisserie chicken dinners. Home Meal Solutions
include pre-cooked dinners which are ready to heat and eat and specially
prepared entrees which are pre-seasoned and ready to cook. Hughes stores also
offer kids' meals and specialty and made-to-order hot and cold sandwiches.
Certain stores also offer self-serve salad, soup and hot buffet bars, and
freshly prepared sushi. Management intends to further develop and implement
specialty and convenience-oriented departments at Hughes stores, which it
believes can be important tools to enhance margins, increase foot traffic and
build customer loyalty. Hughes carries a large variety of certain product
groups, such as kosher, Mexican and Asian foods that are adjusted on a
store-by-store basis to match local demographics.
COMPETITIVE PRICING AND PROMOTIONS. Hughes' management believes that Hughes
provides its customers with competitive prices in a variety of ways. Hughes has
designed and implemented specific programs to promote customer loyalty through
competitive pricing, including a "double coupon" program introduced in the
greater Los Angeles area and a "red tag" program in which red tags extend from
shelves to draw shoppers to special value items, certain of which are tied in to
Hughes' radio advertisements and direct mail promotions. In addition, Hughes
offers a 5% discount on eligible purchases to senior citizens through its Hughes
"Senior Discount" card. Hughes also honors competitors' coupons, and often gives
discounts on equivalent products in cases where Hughes does not carry a
particular item.
DEVELOPMENT OF PROPRIETARY BRANDS. Although Hughes has in the past focused
primarily on national brands, Hughes' management believes that the recent
addition of proprietary brand items has contributed to sales while also
increasing customer loyalty. Hughes currently uses a two-tier proprietary brand
program which includes the "Hughes" label, designed to compete with the national
brands on price and quality, and the "Premier" label which Hughes attaches to
its premium quality items. Hughes currently carries 449 SKUs under its
proprietary brand program and management intends to increase that number in the
future.
STORE BASE AND DEVELOPMENT
Hughes has grown primarily through site acquisition and development by
focusing initially on the San Fernando Valley region of California and then on
other selected parts of the Los Angeles area. Because Hughes began its store
expansion in Los Angeles more than 40 years ago, it has been able to develop a
stable base in Los Angeles County where newer competitors are limited by such
barriers to entry as the high cost of real estate and significant zoning
restraints. Hughes has pursued expansion from its base in Los Angeles County by
selectively entering other markets in Southern California. For example, in 1979
Hughes entered the Orange County market by acquiring five stores and has since
built its presence in Orange County to twelve stores. Hughes entered the
Riverside and San Bernardino markets in 1984 and now has three and seven stores,
respectively, in those markets. Hughes also currently operates four stores in
Ventura County. Hughes management has been highly selective when choosing a site
for a new store, typically requiring a minimum population and demographic
profile before acquiring the site.
Hughes' management believes that its modern store base has been a
significant element in its success. Hughes has invested approximately $161
million in capital expenditures during the most recent five fiscal years, which
have been primarily allocated toward acquiring and building new stores and
expanding or remodeling existing stores. During that period, Hughes has added
over 380,000 square feet through the construction of 14 stores and through
expansion of certain existing stores. At December 31, 1996, the total square
footage of all 56 Hughes stores was approximately 2,086,000 square feet with an
average store size of 37,000 square feet, and a range in size of 22,000 to
55,000 square feet. Hughes increased its total square footage by 0.2%, 4.5% and
2.3% in fiscal 1994, 1995 and 1996, respectively.
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The following table sets forth certain information with respect to Hughes'
store size:
<TABLE>
<CAPTION>
NUMBER OF STORES AT
JANUARY 31, 1997
-----------------------
<S> <C>
Store size:
Between 20,000 and 30,000 square feet..................................... 5
Between 30,000 and 40,000 square feet..................................... 36
Between 40,000 and 50,000 square feet..................................... 13
Over 50,000 square feet................................................... 2
--
56
</TABLE>
Hughes also seeks to refurbish its stores approximately every five to eight
years. Over the last seven full fiscal years Hughes has remodeled 28 stores and
approximately 69% of the total square footage of Hughes' stores is either newly
constructed or was remodeled during the last seven years.
The following table sets forth additional information concerning Hughes
stores for the periods indicated:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-------------------------------------------------------------------------------------
MARCH 1, FEBRUARY 29, FEBRUARY 27, FEBRUARY 26, MARCH 3,
1992 1993 1994 1995 1996
------------- ----------------- ----------------- ----------------- -------------
<S> <C> <C> <C> <C> <C>
TOTAL STORES
Beginning of period........................ 49 52 51 51 53
Newly constructed........................ 3 0 0 2 1
Acquired................................. 0 0 0 0 0
Closed................................... 0 1 0 0 0
-- -- -- -- --
End of period.............................. 52 51 51 53 54
REMODELS..................................... 4 3 6 4 4
<CAPTION>
MARCH 4, 1996
THROUGH
JANUARY 31, 1997
-----------------
<S> <C>
TOTAL STORES
Beginning of period........................ 54
Newly constructed........................ 3
Acquired................................. 0
Closed................................... 1
--
End of period.............................. 56
REMODELS..................................... 2
</TABLE>
PURCHASING AND DISTRIBUTION
Until the early 1980s, Hughes purchased most of its products from
wholesalers. Since that time, Hughes has moved toward direct purchases from
suppliers and self-distribution, leasing a 200,000 square foot dry goods
warehouse in 1983. In 1993, in order to provide for future expansion in the
region and to provide self-distribution capacity for a wider range of products,
Hughes relocated into a 600,000 square foot distribution facility in Irwindale,
California that it designed, constructed and currently owns. Hughes' management
believes that this distribution center is currently operating at approximately
50% of its full capacity. The current distribution facility is centrally located
an average of 44 miles from Hughes' stores and is serviced by a fleet of 36
tractors and approximately 70 trailers, including approximately 60 refrigerated
trailers, all of which are owned by Hughes.
The distribution facility allows Hughes to centralize purchasing, which
Hughes management believes results in certain advantages. For example,
centralized purchasing allows Hughes to take advantage of the benefits of
purchasing large quantities, including volume discounts. Hughes' management also
believes that centralization enables Hughes to help ensure that its quality
standards are applied uniformly and reduces vendor distribution costs by
enabling Hughes to pick up merchandise directly from its suppliers. In addition,
Hughes uses computerized inventory control and ordering systems for items that
are supplied through the distribution facility in order to enhance productivity
and efficiency. Warehouse supplied items are purchased under a central buying
arrangement designed to promote cost-effective buying, quality control and ample
inventory. Hughes' management believes the move toward increased
self-distribution has had a positive impact on Hughes' gross margins.
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<PAGE>
Hughes purchases its merchandise directly from manufacturers as well as from
distributors. In fiscal 1996, Hughes purchased $68.9 million of goods
(approximately 8% of its cost of sales, including distribution and occupancy
expenses) from Certified Grocers ("Certified"), a member-owned cooperative.
Hughes uses Certified primarily for purchases of items it does not carry in its
warehouse, such as frozen foods, ice cream, and certain low turnover items.
Recently, Hughes has focused on implementing a category management program
pursuant to which it will review all aspects of a product category, from
promotional sales to shelf space allocation. Working with enhanced technology
intended to better manage data from checkout lane scanners, together with an
outside consultant, Hughes intends to improve purchasing decisions, gain greater
inventory control and implement "just-in-time" delivery programs. It is expected
that this category management program will lead to closer relationships and
programs with its suppliers. Hughes' management believes that category
management and managing product categories as individual business units can be
important tools to enhance gross margins.
MANAGEMENT INFORMATION SYSTEMS
Hughes' management believes that a high level of computerization is
essential to maintaining and improving Hughes' competitive position and is
committed to the further development and use of information systems as a tool to
enhance results of operations. For example, Hughes uses computerized information
systems, including its IBM ES-9000-411 mainframe computer, to process
transactions and to provide information relating to (1) ordering, purchasing and
billing and (2) reports on sales, inventories, gross profits, payroll, payables
and expenses which are integrated with financial reports which enable management
to better monitor results of operations. Hughes also uses a private voice and
data network for communications and a LAN system which ties its stores,
headquarters and warehouse to the mainframe computer. Hughes also uses an
electronic payment system which enables customers to pay with debit and credit
cards. Hughes also has a direct store delivery system for non-perishable
deliveries which integrates the receipt of goods at the store with accounting
and merchandising at Hughes' main offices. In addition, Hughes is installing new
computer-based point-of-sale hardware and software in the checkout lanes of each
of its supermarkets. As of January 31, 1997, this new technology had been
installed in 26 stores, and is scheduled to be installed in the remaining Hughes
stores by the end of 1997.
MARKETING AND PROMOTION
Hughes advertises through a variety of means, including newspapers,
television and radio. In 1996, Hughes' management began to place a greater
emphasis on the use of direct mail circulars, which it believes are particularly
effective because they enable Hughes to directly target potential customers
living within its stores' marketing area. In addition, Hughes is able to produce
these direct mail circulars in-house which enables it to more effectively
control production costs. In the seven months ended September 29, 1996,
approximately 31% of Hughes' advertising expenditures was spent on newspaper
advertising, 22% was spent on television and radio advertising and 47% was spent
on direct mail circulars.
In addition, Hughes' in-store marketing includes third party product
demonstrations and free product samples. As part of its ongoing efforts to build
customer loyalty and be a good corporate citizen, Hughes and its employees are
also involved in the communities that they serve and participate in a number of
special events.
COMPETITION
The retail supermarket business in Southern California is highly
competitive. Hughes competes primarily with national and regional supermarket
chains, including Ralphs/Food 4 Less, Vons/Pavilions, Lucky, Stater and
Albertson's, with smaller chains and independent stores as well as wholesale
club formats, such as Price/Costco, and specialty and convenience stores.
S-76
<PAGE>
The principal areas of competition include store location; product location
and quality; convenience and cleanliness; employee friendliness and service;
price; and management information enabling timely product selection, pricing and
promotion decisions. Hughes seeks to address each of these factors, emphasizing
superior customer service, high quality perishables, competitive prices, the use
of technology and favorable store locations. Competitive pricing is implemented
by reviewing competitors' prices on a regular basis through observation and
independent surveys and adjusting prices as management deems appropriate.
Certain of these strategies are also used by Hughes' competitors, some of which
have substantially greater financial and other resources than Hughes.
EMPLOYEES AND LABOR RELATIONS
At December 31, 1996, Hughes had approximately 5,000 employees, of which
approximately 30% were full-time and 70% were part-time employees. Approximately
300 of Hughes' employees worked in Hughes' distribution center and approximately
4,600 were unionized employees. Hughes' most significant union contract is with
the United Food and Commercial Warehouse Workers Union which covers
approximately 4,100 of Hughes' retail clerks and which is due to expire in
October 1999. The remaining collective bargaining agreements, which cover
approximately 300 employees, expire at various dates in the period from
September 1998 to October 1999. Two labor contracts, covering a total of
approximately 200 employees, have recently expired and Hughes presently is in
discussion with the applicable unions and anticipates that satisfactory
contracts will be negotiated. Hughes has not had a work stoppage in over 10
years and believes its labor relations are good. However, there can be no
assurance that work stoppages or other labor matters will not adversely affect
the Company in the future.
PROPERTIES
Hughes currently operates a total of 56 stores in Southern California.
Thirty stores are located in Los Angeles County, 12 in Orange County, seven in
San Bernardino County, four in Ventura County and three in Riverside County. Of
these 56 stores, 53 stores are leased, including five stores that are leased to
partnerships in which ownership interests are held by various members of the
Hughes family. Hughes' management believes that these leases are on terms not
less favorable to Hughes than could have been obtained had the properties been
leased from unrelated parties. Hughes' leases generally provide for a 25 year
initial term and for contingent rent based on sales. At December 31, 1996, the
average remaining term on Hughes' leases, including unexercised options to
extend, was approximately 25 years. Two of these leases are due to expire in the
next five years. While Hughes management anticipates renegotiating these leases,
there can be no assurance in this regard and, in any event, any such
renegotiated leases may result in higher rent expense.
In addition, Hughes directly owns three of its stores. At December 31, 1996,
mortgages on these stores totalled approximately $1 million. Hughes also owns
its 600,000 square foot distribution facility and its headquarters, both of
which are located on a 38 acre parcel of land in Irwindale, California.
SEASONALITY
No material portion of Hughes' business is affected by seasonal
fluctuations, except that sales are generally stronger surrounding holidays,
especially from Thanksgiving through New Year's Day. In addition, Hughes' fiscal
year ends on the Saturday closest to the last day of February and generally
consists of 52 weeks. However, fiscal year 1996 was a 53 week year.
ENVIRONMENTAL MATTERS
Under applicable Environmental Laws, Hughes may be responsible for
remediation of environmental conditions and may be subject to associated
liabilities (including liabilities resulting from lawsuits brought by private
litigants) relating to its stores and the land on which its stores are situated,
regardless of whether
S-77
<PAGE>
Hughes leases or owns the stores or land in question and regardless of whether
such environmental conditions were created by Hughes or by a prior owner or
tenant.
Hughes believes it currently conducts its business, and in the past has
conducted its business, in substantial compliance with applicable Environmental
Laws and regulations. In addition, compliance with federal, state and local laws
enacted for protection of the environment has had no material effect on Hughes.
However, there can be no assurance that environmental conditions relating to
prior, existing or future stores or store sites will not have a material adverse
effect on the Company. See "Risk Factors-- Environmental Matters."
In connection with the Hughes Acquisition, QFC reviewed existing reports and
retained environmental consultants to conduct an environmental audit of Hughes'
operations in order to identify conditions that could have material adverse
effects on the Company. QFC is in the process of obtaining final reports on the
results of such audit with regard to Hughes and does not believe such reports
will reveal any environmental matter that is likely to have a material adverse
effect on the Company.
LEGAL PROCEEDINGS
Hughes is currently involved in a number of legal proceedings which have
arisen in the ordinary course of business. Management believes these proceedings
will not, in the aggregate, have a material adverse effect on the Company.
However, the Company is unable to predict whether the outcome of such actions
may or may not have a material adverse effect on the Company's results of
operations in a particular future period as the timing and amount of any
resolution of such actions and their relationship to future results of
operations are not known.
SANTEE DAIRIES
Each of Hughes and Stater owns a 50% interest in Santee, which operates one
of the largest dairy plants in California. Santee processes, packages and
distributes fluid whole, 2%, 1% and skim milk, as well as orange juice, fruit
drinks and certain cultured products under the KNUDSEN, FOREMOST and certain
store brand names. While Hughes' management believes that all of Santee's
products have a reputation for high quality, Santee promotes KNUDSEN as its
premium label. Santee is the exclusive licensee of the KNUDSEN trademark from
Kraft for fluid milk, juices and certain cultured items in the Southern
California market. In addition, Santee is the exclusive licensee from Foremost
Farms, USA, of the FOREMOST trademark for fluid milk in Southern California.
Santee also processes, packages and distributes Hershey chocolate milk under
license and processes and packages orange juice for Sunkist. In calendar 1995,
Santee processed approximately 70 million gallons of fluid products, including
approximately 54 million gallons of fluid milk and in calendar 1996 processed
approximately 73 million gallons of fluid products and approximately 54 million
gallons of fluid milk. During calendar 1996, Santee sold an aggregate of
approximately 60% of its fluid product volume to its owners, Hughes and Stater.
During calendar 1996, Stater purchased more than twice as much fluid milk from
Santee than did Hughes. Santee also sells to various non-owner grocery
supermarkets, independent food distributors, military bases and food service
providers in Southern California and surrounding areas.
Santee's existing dairy plant was built in 1914 at its current location. Due
to the age of the plant, Santee has been required to make significant
expenditures for repairs and maintenance over the past several years. Despite
these investments, operating costs have continued to rise. In order to provide a
consistent source of milk to accommodate expected expansion at both Hughes and
Stater, and in order to contain costs, Santee has begun construction of a new
dairy plant in the City of Industry, California. Hughes' management believes
that the new facility, which is expected to be fully operational by March 1998,
will increase Santee's capacity to process milk from approximately 250,000
gallons per day to approximately 350,000 gallons per day, with the ability to
expand capacity to approximately 500,000 gallons per day. Hughes expects that
the new facility, when fully operational, will also lower Santee's costs of
S-78
<PAGE>
producing fluid milk and other products, and that automation at the new facility
will permit Santee to operate two daily shifts instead of three, thus reducing
its labor costs. However, as with any major construction and capital expenditure
project, the realization of these anticipated benefits is subject to a number of
risks and uncertainties and there can be no assurance that these benefits will
be realized. See "Risk Factors--Risks Relating to Santee Dairies."
Construction costs of the new dairy are estimated to be approximately $100
million, including production equipment and capitalized interest and other
costs. However, there can be no assurance that the cost of the new dairy will
not exceed this amount. To provide the funds necessary to finance the
construction, Santee is seeking to issue $80 million of secured senior notes
(the "Santee Notes") in a private placement, the primary terms of which have
been orally agreed to in principle. In addition, it is expected that Hughes and
Stater will agree to purchase their fluid milk requirements from Santee on terms
that would require that each of Hughes and Stater pay increased milk prices to
the extent necessary to maintain Santee's debt service coverage ratio and fixed
charge coverage ratio above specified levels. See "Risk Factors--Risks Relating
to Santee Dairies" and "Description of Certain Indebtedness--Santee Dairies."
It is expected that Santee, Stater and Hughes will enter into a
Stockholders' Agreement (the "Stockholders' Agreement") which is expected to
provide for the composition and replacement of Santee's Board of Directors and
the election of the Chairman of Santee's Board of Directors, and which is also
expected to describe certain matters requiring super-majority voting. In
addition, the Stockholders' Agreement is expected to provide a right of first
refusal to Santee (or, if Santee does not exercise such right, to the other
stockholder of Santee) in the event of a transfer of shares by either Hughes or
Stater, subject to certain exceptions. The Stockholders' Agreement also is
expected to provide that in the event either Hughes or Stater offers to purchase
all of the stock held by the other, the offeree stockholder shall have the
option either to accept such offer or to purchase the shares of the party making
such offer on substantially equivalent terms and conditions.
Santee had approximately 500 employees as of the end of 1996, of which
approximately 400 were unionized. According to Hughes' management, Santee has
not experienced a work stoppage since Hughes made its investment in Santee in
1986 and believes its labor relations are good. However, there can be no
assurance that work stoppages or other labor matters will not adversely affect
Santee in the future.
Santee's other 50% owner, Stater, a subsidiary of Stater Bros. Holdings,
Inc., is a leading Southern California supermarket chain, operating
approximately 110 supermarkets located primarily in the Inland Empire region of
Southern California (consisting primarily of Riverside and San Bernardino
Counties, but also including parts of Orange, Kern and Los Angeles countries).
In calendar 1996, Stater purchased more than twice as much fluid milk from
Santee than did Hughes. According to publicly available information, Stater had
approximately $1.7 billion of sales and $59.8 million of EBITDA for the fiscal
year ended September 29, 1996.
S-79
<PAGE>
MANAGEMENT
The executive officers and directors of the Company are set forth below.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------------------ --------- -----------------------------------------------------------
<S> <C> <C>
Stuart M. Sloan 53 Chairman of the Board
Christopher A. Sinclair 46 President, Chief Executive Officer and Director(1)
Dan Kourkoumelis 45 President, Chief Executive Officer and Director(1)
Marc W. Evanger 42 Vice President, Chief Financial Officer and
Secretary/Treasurer
Frederick Meils 55 Senior Vice President, Corporate Development
John W. Creighton, Jr. 64 Director
Maurice F. Olson 52 Director
Marc H. Rapaport 40 Director
Sheli Z. Rosenberg 55 Director
Ronald A. Weinstein 55 Director
Samuel Zell 55 Director
</TABLE>
- ------------------------
(1) If the anticipated Reorganization is consummated, Mr. Sinclair will become
President and Chief Executive Officer of Parent and Holding Company while
Mr. Kourkoumelis will remain President and Chief Executive Officer of QFC.
Roger Hughes will remain chief executive officer of Hughes.
It is expected that Roger Hughes will be nominated for a seat on the Board
of Directors of the Company at the next annual meeting of shareholders of the
Company.
QFC's Articles of Incorporation (the "Articles") provide that the Board of
Directors is divided into three classes: Class I, Class II and Class III. Each
Class is as nearly equal in number as possible. Unless a director has been
appointed to fill a vacancy or to fill a position that was created by increasing
the number of directors, each director serves for a term ending at the third
annual shareholders' meeting following the annual meeting at which such director
was elected. Each director serves until such director's successor is elected and
qualified or until such director's earlier death, resignation or removal. The
terms of Class I directors expire at the 1997 annual meeting, the terms of Class
II directors expire at the 1998 annual meeting, and the terms of Class III
directors expire at the 1999 annual meeting.
Two designees of Zell Chilmark (Mr. Zell and Mrs. Rosenberg) are members of
QFC's Board of Directors in accordance with the terms of the Recapitalization
and Stock Purchase and Sale Agreement dated as of January 14, 1995 (the
"Recapitalization Agreement") among QFC, Stuart M. Sloan and Zell Chilmark. A
Standstill Agreement dated as of January 14, 1995 between QFC and Zell Chilmark
(the "Zell Chilmark Standstill Agreement") provides that (i) Zell Chilmark will
continue to have two designees on QFC's Board as long as Zell Chilmark
beneficially owns at least 10% of the outstanding Common Stock; (ii) QFC will
not increase the size of its Board beyond nine members as long as Zell Chilmark
is entitled to two Board designees; and (iii) with certain exceptions, Zell
Chilmark will vote its Common Stock for the election or removal of directors of
QFC either (A) in accordance with the recommendations of a majority of QFC's
disinterested directors or (b) in the same proportion as the other shareholders
vote on such matter. The Zell Chilmark Standstill Agreement also imposes
limitations on how Zell Chilmark may vote its Common Stock with respect to any
matter that would relate to a possible change in control of
S-80
<PAGE>
QFC. Additional provisions of the Zell Chilmark Standstill Agreement are
described below under "Principal Shareholders" and "Shares Eligible For Future
Sale."
Stuart M. Sloan became a director of QFC in 1985 and has been Chairman of
the Board since June 1986. Mr. Sloan served as Chief Executive Officer of QFC
from June 1986 to February 1987 and again from April 1991 to September 1996. Mr.
Sloan is the founder and a principal of Sloan Capital Companies, a private
investment company. Mr. Sloan serves as a director of Anixter International,
Inc., TeleTech Holdings, Inc. and Cucina! Cucina!, Inc. Mr. Sloan is a Class II
director.
Christopher A. Sinclair has been a director and President and Chief
Executive Officer of QFC since September 1996. From 1984 to July 1996, Mr.
Sinclair served as a senior executive officer of Pepsico, Inc. and most recently
served as Chairman and Chief Executive Officer of PepsiCola Company. Prior to
1984, Mr. Sinclair was a marketing executive with General Foods, Frito-Lay and
Newsweek. Mr. Sinclair is a director of Mattel, Inc., Perdue Farms, Inc. and
Woolworth Corporation. Mr. Sinclair is a Class II director.
Dan Kourkoumelis became a director of QFC in April 1991. He joined QFC as a
courtesy clerk in 1967 and his experience includes several ranks of store
management and executive positions. Mr. Kourkoumelis was appointed Executive
Vice President in 1983, Chief Operating Officer in 1987, President in 1989 and
Chief Executive Officer in 1996. Mr. Kourkoumelis is a member of the Board of
Directors of the Western Association of Food Chains and Washington Food Industry
and serves as a director of Associated Grocers, Incorporated and Expeditors
International of Washington, Inc. Mr. Kourkoumelis is a Class III director.
Marc W. Evanger joined QFC in 1984 as Controller. From 1978 to 1984, he was
employed by Price Waterhouse as a Certified Public Accountant in audit,
consulting, corporate tax planning and merger assignments. His prior experience
included three years with QFC as a retail clerk. He was appointed Vice President
in March 1986, Chief Financial Officer in February 1987 and Corporate Secretary
and Treasurer in February 1988.
Frederick S. Meils has been Senior Vice President for Corporate Development
of QFC since January 1997. From 1971 to 1996, Mr. Meils was employed by Pepsico,
Inc. and most recently served as Executive Vice President of Pepsi-Cola
International. From 1989 to 1994, Mr. Meils served as President, Pepsi-Cola
International Western Europe and from 1985 to 1989, he served as Executive Vice
President, Pepsi-Cola North America. From 1983 to 1985, he also served as
President, Pepsi-Cola International Philippines. Prior to 1985, Mr. Meils served
as Senior Vice President of Finance, Pepsi-Cola International, Vice President of
Financial Planning, Pepsico, Inc. and Vice President of Manufacturing,
Pepsi-Cola North America.
John W. Creighton, Jr. became a director of QFC in December 1989. He has
served since 1988 as President and a director, and since August 1991 as Chief
Executive Officer, of Weyerhaeuser Company, a forest products company. Mr.
Creighton serves as a director of NHP, Inc., Portland General Corporation and
Unocal. Mr. Creighton is a Class I director.
Maurice F. Olson became a director of QFC in March 1995. Mr. Olson was
formerly Chairman and Chief Executive Officer of Olson's Food Stores, Inc. Mr.
Olson is the controlling member of Olson Management Group, LLC, a real estate
development and management company, and a member of the Board of Directors of
Associated Grocers, Incorporated. Mr. Olson is a Class II director.
Marc H. Rapaport became a director of QFC in May 1996. Mr. Rapaport is
currently Chairman and lead investor of LA Soccer Partners, L.P. He was a
co-founder of the Capital Division of Jefferies and Company, Inc. in 1990 and
served as Executive Vice President and director of corporate finance until 1994.
Prior to 1990, Mr. Rapaport served as Executive Vice President and co-director
of Domestic Capital Markets at Drexel Burnham Lambert. Mr. Rapaport is a member
of the Board of Governors of Cedars-Sinai Hospital. Mr. Rapaport is a Class I
director.
S-81
<PAGE>
Sheli Z. Rosenberg has been President and Chief Executive Officer since
November 1994 of Equity Group Investments, Inc. and its subsidiary Equity
Financial and Management Company, both privately owned real estate and corporate
investment and management firms; and has been an executive officer and director
for more than the past five years of both of these companies; has been Chairman
of the Board of the law firm of Rosenberg & Liebentritt, P.C. since 1980; is a
director of Anixter International Inc., Capsure Holdings Corp., Sealy
Corporation, Falcon Building Products, Inc., American Classic Voyages Co., Revco
D.S., Inc. and Jacor Communications, Inc.; is a trustee of Equity Residential
Properties Trust; was an executive officer and director until October 4, 1991 of
Madison Management Group, Inc. which filed a petition under Chapter 11 of the
Bankruptcy Code in November 1991; and has been Vice President of First Capital
Benefit Administrators, Inc., which filed a petition under the federal
bankruptcy laws in January 1995. Mrs. Rosenberg is a Class III director.
Ronald A. Weinstein served as a director of QFC from June 1986 to March 1987
and became a director again in February 1988. He was a principal of Sloan
Capital Companies, a private investment company, from 1984 to July 1991. From
February 1989 until April 1991, Mr. Weinstein served as Executive Vice President
of Merchandising at Egghead, Inc., a reseller of microcomputer software. Mr.
Weinstein serves as Chairman of B & B Auto Parts, Inc. and is a director of
Molbak's, Inc. and Coinstar, Inc. Mr. Weinstein is a Class III director.
Samuel Zell became a director of QFC on March 29, 1995. Mr. Zell is, and
since 1981 has been, Chairman of the Board of Equity Financial and Management
Company and, since 1986 has been, Chairman of the Board of Equity Group
Investments, Inc.; is, and since mid-1990 has been, one of two individuals who
control the general partners of the general partner of Zell Chilmark; is, and
since 1985 has been, Chairman of the Board of Anixter International Inc., a
company engaged in the distribution of wiring systems products; from 1987 has
served as Chairman of the Board and Chief Executive Officer of Capsure Holdings
Corp., a company engaged in the business of specialty property and casualty
insurance; is, and since 1992 has been, Co-Chairman of Revco D.S., Inc., a
company that operates a chain of retail drug stores; and from August 1993 to the
present has been Chairman of the Board of American Classic Voyages Co., a
provider of overnight cruises in the United States; is, and since 1993 has been,
Chairman of the Board of Equity Residential Properties Trust, a
self-administered, self-managed equity real estate investment trust; and from
1993 to March 1995 was Co-Chairman, and from March 1995 to the present has been,
Chairman of the Board and Chief Executive Officer of Manufactured Home
Communities, Inc., a self-administered and self-managed equity real estate
investment trust which owns and operates properties in 16 states and since 1996
has been a non-executive director of Ramco Energy PLC, an independent oil
company based in the United Kingdom. Mr. Zell is also a member of the board of
directors of Sealy Corporation. Prior to October 4, 1991, Mr. Zell was President
of Madison Management Group, Inc., which filed a petition under Chapter 11 of
the Bankruptcy Code on November 8, 1991. Mr. Zell is a Class I director.
S-82
<PAGE>
PRINCIPAL SHAREHOLDERS
The only outstanding voting securities of QFC are shares of Common Stock,
which are entitled to one vote per share. At January 31, 1997, there were issued
and outstanding 14,649,945 shares of Common Stock.
The following table sets forth information, as of January 31, 1997, with
respect to all shareholders known by QFC to be the beneficial owners of more
than five percent of its outstanding shares of Common Stock. It also shows
beneficial ownership for each director and executive officer. Except as noted
below, each person has sole voting and investment power with respect to the
shares shown as of such date.
<TABLE>
<CAPTION>
AMOUNT AND
NATURE PERCENT OF
OF BENEFICIAL SHARES
NAME AND ADDRESS(1) OWNERSHIP(2) OUTSTANDING
- ---------------------------------------------------------------- -------------- ---------------
<S> <C> <C>
Stuart M. Sloan(3).............................................. 1,857,882 12.0%
Christopher A. Sinclair......................................... 500,000(4) 3.2
Ronald A. Weinstein............................................. 296,559 1.9
Maurice F. Olson................................................ 599,608 3.9
Zell/Chilmark Fund L.P.(5)(6)................................... 3,975,000 25.6
Samuel Zell(5)(6)............................................... 3,981,667 25.6
Sheli Z. Rosenberg(5)(6)........................................ 3,975,000 25.6
Dan Kourkoumelis................................................ 118,123 *
John W. Creighton, Jr........................................... 14,075 *
Marc H. Rapaport................................................ 0 0
Marc W. Evanger................................................. 76,254 *
Frederick Meils................................................. 0 0
All executive officers and directors as a group (11 persons).... 7,443,365 47.9
</TABLE>
- ------------------------
* Denotes less than one percent.
(1) The business address of each holder identified as the beneficial owner of
more than five percent of the Common Stock other than Zell Chilmark, Mr.
Zell and Mrs. Rosenberg is 10112 N.E. 10th Street, Bellevue, Washington
98004. The business address of Zell Chilmark, Mr. Zell and Mrs. Rosenberg is
Two North Riverside Plaza, Chicago, Illinois 60606.
(2) Includes shares that may be acquired within 60 days through the exercise of
stock options, as follows: Mr. Sloan, 158,900 shares; Mr. Sinclair, 500,000
shares; Mr. Weinstein, 12,000 shares; Mr. Olson, 6,667 shares; Mr.
Kourkoumelis, 111,985 shares; Mr. Zell, 6,667 shares; Mr. Creighton, 10,200
shares; Mr. Rapaport, 0 shares; Mr. Evanger, 71,484 shares; Mr. Meils, 0
shares; and all executive officers and directors as a group, 877,903 shares.
(3) In connection with the Recapitalization, Mr. Sloan and QFC entered into a
Standstill Agreement dated as of January 14, 1995 (the "Sloan Standstill
Agreement") pursuant to which Mr. Sloan agreed that he will not take any of
the following actions, subject to specified limited exceptions: (a) sell or
otherwise dispose of any Common Stock prior to March 29, 1997 (except (i)
for the sale by Mr. Sloan to Zell Chilmark of 2,975,000 shares of Common
Stock (which occurred on January 16, 1996), (ii) in response to certain
tender or exchange offers and (iii) for charitable bequests of Common Stock
in an aggregate amount not exceeding 200,000 shares); (b) form, join or
participate in any other way in a partnership, voting trust or other "group"
(as such term is defined under Section 13(d) of the Exchange Act), or enter
into any agreement or arrangement or otherwise act in concert with any other
person, for the purpose of acquiring, holding, voting or disposing of Common
Stock; (c) engage in any material transactions with QFC without the approval
of a majority of QFC's disinterested directors; or (d) engage in certain
specified takeover actions or take any other actions, alone or in concert
with any other person, to seek control of QFC or otherwise seek to
circumvent any of the foregoing limitations.
(4) Represents shares that may be acquired through the exercise of stock
options.
(5) By virtue of their positions with the entities that indirectly control the
general partner of Zell Chilmark, Mr. Zell and Mrs. Rosenberg may be deemed
to beneficially own the shares of Common Stock beneficially owned by Zell
Chilmark. Mr. Zell and Mrs. Rosenberg disclaim beneficial ownership of such
shares.
(FOOTNOTES CONTINUED ON FOLLOWING PAGE)
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(FOOTNOTES CONTINUED FROM PRECEDING PAGE)
(6) Pursuant to the Zell Chilmark Standstill Agreement, Zell Chilmark has agreed
that it and certain of its affiliates will not take any of the following
actions without the approval of a majority of QFC's disinterested directors,
subject to specified limited exceptions: (a) increase their ownership of
Common Stock (or securities convertible into or exchangeable for Common
Stock or other options or rights to acquire Common Stock) prior to June 30,
2000 beyond 30%; (b) sell or otherwise dispose of any Common Stock prior to
March 1997; (c) sell or otherwise dispose of any Common Stock during the
two-year period following March 1997 to any person or group that would own
(to Zell Chilmark's knowledge) more than 5% of the outstanding Common Stock
after such transfer; (d) form, join or participate in any other way in a
partnership, voting trust or other "group" (as such term is defined under
Section 13(d) of the Exchange Act), or enter into any agreement or
arrangement or otherwise act in concert with any other person, for the
purpose of acquiring, holding, voting or disposing of Common Stock; (e)
engage in certain specified takeover actions or take any other actions,
alone or in concert with any other person, to seek control of QFC or
otherwise seek to circumvent any of the foregoing limitations; or (f) engage
in any material transaction with QFC.
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DESCRIPTION OF CERTAIN INDEBTEDNESS
The following description of certain existing and anticipated provisions of
certain indebtedness of the Company and Santee does not purport to be complete,
and is subject to, and is qualified in its entirety by reference to, the forms
of such instruments, copies of which may be obtained as described under
"Available Information."
NEW CREDIT FACILITY
It is expected that the New Credit Facility will consist 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 expected to be due in
quarterly installments from June 30, 1998 through the final maturity of the New
Credit Facility in March 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 expected to be 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 expected 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
$25 million each year (subject to certain possible adjustments) 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 (including guarantees of
indebtedness of Santee) in an amount not to exceed $80 million to finance
construction of Santee's new dairy. The New Credit Facility is expected to
become effective prior to or concurrently with the closing of the Common Stock
Offering and the Notes Offering. The Company anticipates that, on the date the
New Credit Facility becomes effective, the Company will borrow $250 million
under the Term Loan Facility and the Current Credit Facility will be terminated.
See "The Acquisitions--Financing." It is expected that 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. Although QFC
will initially be the sole borrower under the New Credit Facility, in the event
the proposed Reorganization occurs it is expected that Holding Company will
become the borrower under both the Revolving Credit Facility and the Acquisition
Facility, while QFC will remain the borrower under the Term Loan Facility. It is
expected that Hughes, KUI, Holding Company and Parent will initially guarantee
QFC's borrowings under the New Credit Facility. After the Reorganization (if
consummated), borrowings by QFC under the Term Loan Facility are expected to be
guaranteed by Parent, Holding Company and all of Holding Company's existing and
future subsidiaries (excluding QFC and certain foreign subsidiaries and certain
insignificant subsidiaries), and borrowings by Holding Company under the
Revolving Credit Facility and the Acquisition Facility are expected to be
guaranteed by Parent, QFC and all of Holding Company's other existing and future
subsidiaries (excluding certain foreign subsidiaries and certain insignificant
subsidiaries).
It is expected that borrowings and other obligations of the borrowers under
the New Credit Facility, and the guarantees thereof, will be general
unsubordinated obligations of the borrowers and the guarantors and will
constitute Senior Debt for purposes of the Indenture pursuant to which the Notes
will be issued. The Company expects that borrowings and other obligations under
the New Credit Facility and the guarantees thereof will be secured, prior to the
Reorganization, by a pledge of the capital stock of Holding Company, Hughes and
KUI and certain intercompany indebtedness and, after the Reorganization (if
consummated), by a pledge of the capital stock of Holding Company, QFC, Hughes
and KUI and certain intercompany indebtedness, in each case together with
proceeds and products thereof. The Company
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expects that the New Credit Facility will contain a number of significant
covenants that, among other things, will restrict the ability of QFC (and after
the Reorganization, if consummated, Parent) 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 QFC
(and after the Reorganization, if consummated, Parent) and its subsidiaries'
acquisition of other businesses and limit QFC (and after the Reorganization, if
consummated, Parent) and its subsidiaries from making certain restricted
payments (including dividends and repurchases of stock), subject in certain
circumstances to specified financial tests. In addition, the Company expects
that Parent 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. See "Risk Factors-- Restrictive Debt Covenants;
Compliance with Debt Instruments."
The Company expects that the New Credit Facility will contain customary
events of default, including (1) a default triggered by a default in the payment
of outstanding indebtedness in excess of $15 million which permits the
acceleration thereof, (2) any person or group shall acquire beneficial ownership
of 20% or more of the Company (or after the Reorganization, Parent) and such
amount shall be a greater percentage than that beneficially owned by Zell
Chilmark and its affiliates, (3) a majority of the Board of Directors of the
Parent shall not be continuing directors and (4) a "Change of Control" as
defined in the Indenture relating to the Notes. It is expected that upon the
occurrence of an event of default, lenders holding at least 50% in principal
amount of the outstanding borrowings and commitments would be able to declare
all borrowings under the New Credit Facility to be due and payable and upon the
occurrence of an event of default triggered by certain events of bankruptcy,
insolvency or reorganization, such borrowings would ipso facto become due and
payable. It is expected that upon such an acceleration, the lenders would also
be able to seek to liquidate the collateral pledged as security for the New
Credit Facility and enforce the related guarantees.
THE NOTES
Concurrently with the Common Stock Offering, the Company is selling $150
million aggregate principal amount of its Senior Subordinated Notes due 2007 in
a private offering exempt from the registration requirements of the Securities
Act. The Notes have not been registered under the Securities Act or any state
securities laws and may not be offered or sold in the United States absent
registration or an applicable exemption from registration requirements. The
Common Stock Offering is contingent upon, among other things, the concurrent
completion of the Notes Offering.
The Notes will bear interest at 8.70% per annum, will mature in 2007 and
will be redeemable, in whole or in part, at the option of the Company beginning
in 2002, at redemption prices declining over time from a specified percentage 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 a specified date in 2000 the
Company may redeem up to 20% of the aggregate principal amount of the Notes
originally issued at a specified percentage of the principal amount thereof,
plus accrued and unpaid interest to the date of redemption, with the net cash
proceeds of one or more public offerings of Common Stock of the Company, prior
to the Reorganization, or, after the Reorganization, of Parent; 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 Notes will be guaranteed on an unsecured senior subordinated basis (the
"Guarantees"), prior to the Reorganization, by all of QFC's existing and future
subsidiaries (including Holding Company but excluding Parent and Unrestricted
Subsidiaries and Non-Guarantor Foreign Subsidiaries (as such terms are defined
in the Indenture) of the Company) and, after the Reorganization (if
consummated), by Holding Company and all of Holding Company's existing and
future subsidiaries (excluding QFC (which
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will remain the obligor on the Notes) and Unrestricted Subsidiaries and
Non-Guarantor Foreign Subsidiaries of Holding Company) (collectively, the
"Guarantors"). It is anticipated that the initial Guarantors will be Holding
Company, Hughes and KUI. The Notes will not be guaranteed by Parent.
The Notes and the Guarantees will be general unsecured obligations of the
Company and the Guarantors, respectively, subordinated in right of payment to
all existing and future Senior Debt (as defined) of the Company and the
Guarantors, as applicable, including borrowings and guarantees under the New
Credit Facility.
Upon a Change of Control (as defined in the Indenture), 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 will contain certain covenants that will
limit, subject to certain significant exceptions, the ability of, prior to the
Reorganization, the Company and its Subsidiaries (as defined) and, following the
Reorganization, Holding Company and its Subsidiaries (including the Company) 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.
The Indenture will contain customary events of default, including a
cross-default provision triggered by the acceleration or nonpayment of
outstanding indebtedness in excess of a specified amount. Upon the occurrence of
an event of default, the trustee or the holders of at least 25% in outstanding
principal amount of the Notes may declare the Notes to be due and payable or,
upon the occurrence of an event of default triggered by certain events of
bankruptcy, insolvency or reorganization, the Notes ipso facto will become due
and payable.
SANTEE DAIRIES
THE SANTEE NOTES.
Negotiations are currently under way with certain parties to provide Santee
with long-term debt financing which will be used to construct a new dairy plant
at Santee. It is currently expected that the debt financing will take the form
of $80 million aggregate principal amount of senior secured notes due 2007 sold
by Santee to several insurance companies (the "Santee Notes"). As of the date
hereof, the prospective lenders have orally agreed in principle to the primary
terms of the Santee Notes, including the applicable interest rate. However,
there can be no assurance that Santee will be able to issue the Santee Notes on
the terms described below or at all, and the actual terms of any such financing
could differ materially from those described herein. Likewise, there can be no
assurance that Santee will be able to sell the Santee Notes or obtain other
long-term financing for the new dairy, which could have a material adverse
effect on the Company. See "Risk Factors--Risks Relating to Santee Dairies."
It is expected that the Santee Notes will bear interest at a fixed rate,
will mature in 2007 and will be subject to quarterly principal repayments
commencing in the ninth fiscal quarter after issuance. In the event that the new
dairy is not completed and capable of commercial operation in accordance with
agreed upon production levels and economic efficiencies by a specified date, it
is expected that each holder of the Santee Notes will have the right to require
Santee to prepay such holder's Santee Notes, together with a "make-whole
amount." In addition, it is expected that the Santee Notes will be redeemable at
the option of Santee at any time at par plus accrued interest, plus a
"make-whole amount."
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It is expected that the Santee Notes will be secured by collateral including
(i) the assignment of certain Product Purchase Agreements to be entered into
between Santee and Stater and between Santee and Hughes, (ii) the assignment of
raw milk and other supply agreements (to the extent such agreements exist),
(iii) a lien on the real property, equipment and machinery of Santee, (iv) the
assignment of licenses, permits, operating rights, trademarks and patents of
Santee and (v) a pledge by Hughes and Stater of the capital stock of Santee.
The Santee Notes are also expected to contain a number of significant
covenants including (i) a limitation on indebtedness covenant, (ii) a minimum
net worth test, (iii) a debt service ratio covenant, (iv) a fixed charge
coverage ratio covenant, (v) a restricted payments covenant, (vi) a limitation
on liens covenant, (vii) a limitation on sale/leaseback transactions covenant
and (viii) a merger and consolidation covenant, among others. Further, the
Santee Notes are expected to contain provisions prohibiting a change of control
of Santee unless the Santee Notes held by each holder of Santee Notes that so
elects are repurchased, at a price equal to par, plus accrued interest, plus a
"make-whole amount".
It is expected that (i) the Santee Notes and/or the Product Purchase
Agreements will contain provisions requiring that a specified interest and
rental expense coverage ratio of the Company (or if the proposed Reorganization
is consummated, Parent) be maintained and that each of Hughes and Stater
maintain a specified consolidated net worth and a specified fixed charge
coverage ratio and (ii) the Santee Notes will contain customary events of
default, including events of default triggered by the acceleration of debt of
Holding Company and its consolidated subsidiaries aggregating $15 million, the
acceleration of debt of Stater aggregating $10 million, a default by Hughes in
respect of its indebtedness (excluding guarantees of indebtedness of Holding
Company and its consolidated subsidiaries) aggregating $7.5 million, and a
default under certain provisions of the Product Purchase Agreements. If Stater
were to so default, or if indebtedness of Stater in such amount were to be
accelerated, such noncompliance or acceleration could result in increased prices
for products and/or in the acceleration of the Santee Notes. As a result, such
increased prices and/or acceleration may be triggered by events relating to
Stater over which Hughes and Santee have no control and could have a material
adverse effect on the Company.
It is expected that, upon the occurrence of a default in the payment of
interest or principal or make-whole payment, any holder of a Santee Note may
declare such note due and payable and that upon the occurrence of any other
event of default, lenders holding a specified percentage in principal amount of
the Santee Notes will be entitled to declare all of the Santee Notes to be due
and payable and, upon the occurrence of an event of default triggered by certain
events of bankruptcy or insolvency, the Santee Notes will ipso facto become due
and payable. It is expected that upon acceleration of the Santee Notes, the
lenders will be entitled to foreclose upon the collateral pledged to secure the
Santee Notes.
It is expected that each of Hughes and Stater will enter into a Product
Purchase Agreement with Santee in connection with the Santee Notes. The Product
Purchase Agreements are expected to provide that each of Hughes and Stater will
be obligated to purchase all of its fluid milk and specified Santee-produced
products from Santee, subject to certain exceptions, and that each of Hughes and
Stater will be required to pay increased prices to the extent necessary to
maintain Santee's debt service coverage ratio and fixed charge coverage ratio
above specified levels.
SANTEE LINES OF CREDIT.
Santee is presently party to (i) a $6 million credit facility consisting of
a $3.5 million revolver for working capital purposes (the "Santee Revolver") and
a $2.5 million letter of credit supporting workers' compensation claims, (ii) a
$5 million loan to cover construction costs for the new dairy until permanent
financing is established (the "Santee Bridge Loan") and (iii) a $3.5 million
letter of credit supporting a $3.5 million rental payment due in April 1998 upon
expiration of Santee's lease at the existing dairy (collectively, the "Santee
Credit Facilities"). At January 31, 1997, $3.3 million was outstanding under the
Santee Revolver (although balances fluctuate during each month based on raw milk
requirements),
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$300,000 was outstanding under the workers' compensation letter of credit, $5
million was outstanding under the Santee Bridge Loan and $3.5 million was
outstanding under the letter of credit facility. Santee is currently in default
under certain of the financial covenants relating to the Santee Credit
Facilities, and is presently negotiating with its lender to extend the Santee
Credit Facilities and to obtain appropriate waivers. Notwithstanding such
default, its lender has allowed Santee to continue to borrow under the Santee
Revolver without a formal waiver. It is expected that all the Santee Credit
Facilities will remain in place after the Hughes Acquisition except for the
Santee Bridge Loan which is expected to be replaced by long-term dairy
financing, if and when obtained by Santee. Although a default under the existing
Santee Credit Facilities triggers a default under Hughes' revolving credit
facility, and, as a result, Hughes' $32 million credit facility is currently in
default, no borrowings are currently outstanding under the Hughes facility and
such facility will be terminated in connection with the Hughes Acquisition. The
Santee Credit Facilities are secured by a lien on Santee's accounts receivable,
inventory and general intangibles.
Santee is also in the process of arranging short-term interim financing for
certain payments under its construction contract for the new dairy until such
time as it is able to obtain long-term financing. Santee currently owes
approximately $2.1 million for work performed in January of 1997 and expects
payments for February and March of 1997 to be approximately $5.2 million and
$5.5 million, respectively. Such amounts may be financed through a new bridge
facility with Santee's existing or a new lender, loans and/or advances from the
Company, Hughes and/or Stater or amounts available under the Santee Revolver.
There can be no assurance that Santee will be successful in arranging such
interim financing and any failure to make the required payment would cause a
default under the construction contract for the new dairy, which could have a
material adverse effect on the Company.
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DESCRIPTION OF CAPITAL STOCK
The following description of certain terms of QFC's capital stock summarizes
certain provisions of the Washington Business Corporation Act and QFC's Articles
and is subject to and qualified in its entirety by reference to such provisions
and documents.
GENERAL
The Articles currently authorize the issuance of up to 60,000,000 shares of
common stock, par value $.001 per share (the "Common Stock"). The holders of
Common Stock are entitled to receive dividends when, as and if declared by the
Board of Directors out of any funds lawfully available therefor and, in the
event of liquidation or distribution of assets, are entitled to participate
ratably in the distribution of such assets remaining after payment of
liabilities, in each case subject to any preferential rights granted to any
series of Preferred Stock that may then be outstanding. The Common Stock does
not have any preemptive rights. The issued and outstanding shares of Common
Stock are fully paid and nonassessable.
Holders of the shares of Common Stock are entitled to vote in person or by
proxy at all meetings of shareholders of the Company for the election of
directors and for other purposes. Such holders have one vote for each share of
Common Stock held by them. In voting for directors, the Common Stock does not
have cumulative voting rights. The Company's directors are divided into three
classes of approximately equal size and are elected for staggered terms of three
years, with one such class being elected at each annual meeting of shareholders.
The Articles authorize 1,000,000 shares of preferred stock, par value $.001
per share (the "Preferred Stock") and permit the Board of Directors, without
further shareholder authorization, to issue Preferred Stock in one or more
series and to fix the terms and provisions of each series, including dividend
rights and preferences over dividends on the Common Stock; conversion rights, if
any; voting rights, if any (in addition to those provided by law); redemption
rights, if any, and the terms of any sinking fund therefor; and rights on
liquidation, including preferences over the Common Stock, which action could
adversely affect the rights of holders of Common Stock. As of the date hereof,
QFC had no shares of Preferred Stock outstanding.
PROVISIONS AFFECTING ACQUISITION OF THE COMPANY
Except as otherwise described below (and in addition to any voting rights
granted to or held by holders of Preferred Stock), the approval of any merger,
share exchange, sale, lease, exchange or disposition of all or substantially all
of QFC's property, otherwise than in the usual and regular course of business,
or proposal to dissolve, requires the affirmative vote of the holders of not
less than a majority of the outstanding shares of voting stock. In addition, the
Articles provide that (i) any merger, consolidation, combination or
reorganization of the Company with or into any person who, together with its
affiliates or associates or any group of persons that has agreed to act
together, is or becomes the beneficial owner of five percent or more of the
Company's outstanding voting stock who did not, on March 4, 1987, own five
percent or more of the Company's voting stock (an "Interested Person"), (ii) any
sale, lease, exchange, transfer, liquidation or other disposition of more than
ten percent of the Fair Market Value (as defined in the Articles) of the total
consolidated assets of the Company to an Interested Person, (iii) any sale,
lease, exchange, transfer, liquidation or other disposition of more than ten
percent of the Fair Market Value of the total consolidated assets of an
Interested Person to the Company, (iv) any issuance or transfer of any
securities of the Company (other than by way of a pro rata distribution to all
shareholders) to an Interested Person which, when aggregated with all prior
issuances and transfers to such Interested Person of securities of the Company
during the preceding 365 days, constitutes five percent or more of the
outstanding shares of any class or series of securities of the Company, (v) any
acquisition by the Company of one percent or more of any outstanding class or
series of debt or equity securities of an Interested Person, (vi) any
recapitalization or reorganization that would have the effect of increasing the
voting power of an Interested Person and (vii) any agreement or other
arrangement for any of the foregoing transactions (collectively, a "Business
Combination"), must be approved by the vote of at least 66 2/3% of the
outstanding voting stock of the Company, unless the proposed Business
Combination is (a) approved by a
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majority of the directors ("Continuing Directors") who are unaffiliated with
such Interested Person and are not such Interested Person and who were directors
before such Interested Person became an Interested Person or who were elected or
nominated by a majority of the Continuing Directors or (b) structured to provide
for payment of cash or other consideration to the Company's shareholders in a
manner which satisfies certain requirements of the Articles (the "Fair Price
Requirements").
The Fair Price Requirements provide that a Business Combination must provide
for an offer to all holders of each class of equity securities of either cash or
the same type of consideration used by the Interested Person to acquire the
largest number of shares of such class previously acquired by the Interested
Person, and that the value of the consideration must be at least equal to the
highest of (i) the highest price paid by the Interested Person within 18 months
before the date of announcement of the proposed Business Combination (the
"Announcement Date") or in the transaction or series of transactions in which
such person became an Interested Person, (ii) the higher of the Fair Market
Value per share of such class on the Announcement Date or the date on which such
person became an Interested Person and (iii) if applicable, the redemption price
per share of such class or the amount per share such class is entitled to
receive upon liquidation of the Company. The Fair Price Requirements are further
conditioned on approval by the affirmative vote of the holders of a majority of
the Disinterested Shares (as defined in the Articles).
The Articles provide that the provisions of the Articles (i) requiring super
majority approval of Business Combinations involving Interested Persons, (ii)
defining the number of directors of the Company and the classification, election
and removal thereof, (iii) eliminating cumulative voting and preemptive rights,
(iv) providing for indemnification and limitation of liability of directors and
officers, (v) establishing procedures for calling special meetings of
shareholders and for handling shareholder proposals and (vi) establishing the
Company's authorized capital stock, may not be amended without approval (a) by a
majority of the authorized number of directors and, if an Interested Person
exists, by a majority of Continuing Directors or (b) by holders of at least
66 2/3% of the Company's outstanding voting stock.
The foregoing provisions of the Articles as well as the staggered terms for
directors and the availability of Preferred Stock for issuance without
shareholder approval may deter any potential unfriendly offers or other efforts
to obtain control of the Company that are not approved by the Board of Directors
and could thereby deprive the shareholders of opportunities to realize a premium
on their Common Stock and could make removal of incumbent management more
difficult. On the other hand, these provisions may induce any persons seeking
control of the Company or a business combination with the Company to negotiate
terms acceptable to the Board of Directors.
Washington law contains certain provisions that may have the effect of
delaying or discouraging a hostile takeover of the Company. Chapter 23B.19 of
the Washington Business Corporation Act prohibits a "Target Corporation" (as
defined in the Act), with certain exceptions, from engaging in certain
significant business transactions with an "Acquiring Person" (defined generally
as a person who acquires 10% or more of the corporation's voting securities
without the prior approval of the corporation's board of directors) for a period
of five years after such acquisition. The prohibited transactions include, among
others, a merger or share exchange with, disposition of assets to, or issuance
or redemption of stock to or from, the Acquiring Person, or a reclassification
of securities that has the effect of increasing the proportionate share of the
outstanding securities held by the Acquiring Person. An Acquiring Person may
avoid the prohibition against effecting certain significant business
transactions with the Target Corporation if the board of directors of the Target
Corporation, at the time of the share acquisition, approves the proposed
significant business transaction. In addition, an Acquiring Person may avoid the
prohibition against effecting certain significant business transactions with the
Target Corporation if the per share consideration paid to holders of outstanding
shares of common stock and other classes of stock of the Target Corporation
meets certain minimum criteria, although the Company, in its Articles has
expressly elected not to be covered by such statutory exception. These
provisions may have the effect of delaying, deterring or preventing a change in
control of the Company.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock of the Company is
ChaseMellon Shareholder Services.
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SHARES ELIGIBLE FOR FUTURE SALE
After the Common Stock Offering and including the 904,646 shares of Common
Stock issued in the KUI Acquisition and 70,000 shares to be issued in connection
with the acquisition of two stores in late 1996, a total of 20,142,560 shares of
Common Stock (20,817,560 shares, if the over-allotment options are exercised in
full) will be outstanding. 2,178,191 shares of Common Stock are issuable upon
the exercise of outstanding stock options pursuant to its Plans. Of these
shares, the Company has registered 1,751,611 shares under the Securities Act.
All of the shares of Common Stock which will be outstanding immediately
after the Common Stock Offering will be freely tradeable without restrictions
under the Securities Act, except for shares held by "affiliates" (as defined in
regulations under the Securities Act) (including the 3.975 million shares held
by Zell Chilmark) and except for approximately an additional 1,777,587 shares of
Common Stock (the "Restricted Shares"). Sales of these Restricted Shares are
subject to the limitations under Rule 144 ("Rule 144") under the Securities Act.
In general, under Rule 144 as currently in effect, a person (or persons whose
shares are aggregated) who has beneficially owned shares for at least two years,
including an affiliate of the Company, is entitled to sell, within any
three-month period, a number of shares that does not exceed the greater of (i)
1% of the total number of then outstanding shares of the Company's Common Stock
and (ii) an amount equal to the average weekly reported volume of trading in
such shares during the four calendar weeks preceding such sale. A person (or
persons whose shares are aggregated) who is not deemed such an affiliate of the
Company and who has beneficially owned shares for at least three years is
entitled to sell such shares under Rule 144 without regard to these volume
limitations and certain other requirements of such Rule. However, the SEC has
adopted changes to Rule 144 (which are to become effective on April 29, 1997)
which will reduce the foregoing two-year and three-year holding periods to
one-year and two-year holding periods, respectively, which will accelerate the
dates on which Restricted Shares may be resold under such provisions of Rule
144.
The Restricted Shares may also be sold pursuant to a registration statement
filed by the Company under the Securities Act or another exemption from
registration that might be available without compliance with the requirements of
Rule 144. In that regard, the Company has granted registration rights to certain
investors covering approximately 5,752,587 Restricted Shares as described below.
On March 1, 1995, QFC entered into an Investors Rights Agreement with the
previous shareholders of Olson's (the "Olson's Investors") providing for certain
demand and "piggy-back" registration rights with respect to approximately
752,941 shares of Common Stock. The Olson's Investors have the right to one
demand registration until March 1, 2000 and unlimited "piggy-back" rights, in
each case subject to customary related provisions set forth in such Agreement.
QFC is also party to a similar agreement entered into in connection with its
August 1996 acquisition of certain Food Giant stores covering 120,000 shares.
The Food Giant investors have the right to one demand registration commencing in
April, 1997 and unlimited "piggy-back" rights, in each case subject to customary
related provisions. The Zell Chilmark Standstill Agreement entered into in
connection with the Recapitalization also provides certain registration rights
to Zell Chilmark covering the 3.975 million shares owned by Zell Chilmark. Under
the terms of the Zell Chilmark Standstill Agreement, the holders will be
entitled to two demand registrations and unlimited "piggy-back" rights, in each
case subject to customary related provisions set forth in the Zell Chilmark
Standstill Agreement. The Company entered into an Investors Rights Agreement in
connection with the KUI Acquisition covering the 904,646 shares issued in
connection therewith. The holders of such shares are entitled to two demand
registrations commencing on the 60th day prior to February 14, 1999 and
unlimited "piggy-back" rights, in each case subject to customary related
provisions expected to be set forth in such Agreement.
No prediction can be made as to the effect, if any, that future sales of
shares or the availability of shares for sale will have on the market price of
the Common Stock prevailing from time to time. Sales of substantial amounts of
Common Stock in the public market (including shares issued pursuant to the Plans
or upon the exercise of the registration rights described above), or the
perception that such sales may occur, could adversely affect market prices of
the Common Stock.
S-92
<PAGE>
The Company, its executive officers and directors and Zell Chilmark have
agreed that, for a period of 90 days after the date hereof, they will not sell
or otherwise dispose of any shares of Common Stock without the prior written
consent of Merrill Lynch, Pierce, Fenner & Smith Incorporated, in each case
subject to certain limited exceptions.
CERTAIN U.S. TAX CONSEQUENCES TO NON-U.S. HOLDERS
The following is a general discussion of certain United States federal
income and estate tax consequences of the ownership and disposition of Common
Stock by a Non-U.S. Holder. For this purpose, a "Non-U.S. Holder" is any person
who is, for United States federal income tax purposes, a foreign corporation, a
non-resident alien individual, a foreign partnership or a foreign estate or
trust. This discussion does not address all aspects of United States federal
income and estate taxes and does not deal with foreign, state and local
consequences that may be relevant to such Non-U.S. Holders in light of their
personal circumstances. Furthermore, this discussion is based on provisions of
the Internal Revenue Code of 1986, as amended (the "Code"), existing and
proposed regulations promulgated thereunder and administrative and judicial
interpretations thereof, as of the date hereof, all of which are subject to
change. EACH PROSPECTIVE PURCHASER OF COMMON STOCK IS ADVISED TO CONSULT A TAX
ADVISOR WITH RESPECT TO CURRENT AND POSSIBLE FUTURE TAX CONSEQUENCES OF
ACQUIRING, HOLDING AND DISPOSING OF COMMON STOCK AS WELL AS ANY TAX CONSEQUENCES
THAT MAY ARISE UNDER THE LAWS OF ANY U.S. STATE, MUNICIPALITY OR OTHER TAXING
JURISDICTION.
DIVIDENDS
The Company does not currently pay cash dividends on its Common Stock. See
"Price Range of Common Stock and Dividend Policy." Dividends paid to a Non-U.S.
Holder of Common Stock generally will be subject to withholding of United States
federal income tax at a 30% rate or such lower rate as may be specified by an
applicable income tax treaty. However, dividends that are effectively connected
with the conduct of a trade or business by the Non-U.S. Holder within the United
States are not subject to the withholding tax, but instead are subject to United
States federal income tax on a net income basis at applicable graduated
individual or corporate rates. Any such effectively connected dividends received
by a foreign corporation may, under certain circumstances, be subject to an
additional "branch profits tax" at a 30% rate or such lower rate as may be
specified by an applicable income tax treaty.
Under current law, dividends paid to an address outside the United States
are presumed to be paid to a resident of such country (unless the payer has
knowledge to the contrary) for purposes of the withholding tax discussed above
and, under the current interpretation of United States Treasury regulations, for
purposes of determining the applicability of a tax treaty rate. Under proposed
United States Treasury regulations not currently in effect, a Non-U.S. Holder of
Common Stock who wishes to claim the benefit of an applicable treaty rate (and
avoid back-up withholding as discussed below) would be required to satisfy
applicable certification and other requirements. Currently, certain
certification and disclosure requirements must be complied with in order to be
exempt from withholding under the effectively connected income exemption
discussed above.
A Non-U.S. Holder of Common Stock eligible for a reduced rate of United
States withholding tax pursuant to an income tax treaty may obtain a refund of
any excess amounts withheld by filing an appropriate claim for refund with the
Internal Revenue Service (the "IRS").
GAIN ON DISPOSITION OF COMMON STOCK
A Non-U.S. Holder generally will not be subject to United States federal
income tax with respect to gain recognized on a sale or other disposition of
Common Stock unless (i) the gain is effectively connected with a trade or
business of the Non-U.S. Holder in the United States, (ii) in the case of a
Non-U.S. Holder who is an individual and holds the Common Stock as a capital
asset, such holder is present in the United States for 183 or more days in the
taxable year of the sale or other disposition and certain other conditions
S-93
<PAGE>
are met, or (iii) the Company is or has been a "U.S. real property holding
corporation" for United States federal income tax purposes.
The Company has not determined whether it is a "U.S. real property holding
corporation" for federal income tax purposes. If the Company is or becomes a
U.S. real property holding corporation, so long as the Common Stock continues to
be regularly traded on an established securities market, only a Non-U.S. Holder
who holds or held (at any time during the shorter of the five year period
preceding the date of disposition or the holder's holding period) more than five
percent of the Common Stock will be subject to U.S. federal income tax on the
disposition of the Common Stock.
An individual Non-U.S. Holder described in clause (i) above will be taxed on
the net gain derived from the sale under regular graduated United States federal
income tax rates. An individual Non-U.S. Holder described in clause (ii) above
will be subject to a flat 30% tax on the gain derived from the sale, which may
be offset by United States capital losses (notwithstanding the fact that the
individual is not considered a resident of the United States). If a Non-U.S.
Holder that is a foreign corporation falls under clause (i) above, it will be
taxed on its gain under regular graduated United States federal income tax rates
and, in addition, may be subject to the branch profits tax equal to 30% of its
effectively connected earnings and profits within the meaning of the Code for
the taxable year, as adjusted for certain items, unless it qualifies for a lower
rate under an applicable income tax treaty.
FEDERAL ESTATE TAX
Common Stock held by an individual Non-U.S. Holder at the time of death will
be included in such holder's gross estate for United States federal estate tax
purposes, unless an applicable estate tax treaty provides otherwise.
INFORMATION REPORTING AND BACKUP WITHHOLDING TAX
The Company must report annually to the IRS and to each Non-U.S. Holder the
amount of dividends paid to such holder and the tax withheld with respect to
such dividends, regardless of whether withholding was required. Copies of the
information returns reporting such dividends and withholding may also be made
available to the tax authorities in the country in which the Non-U.S. Holder
resides under the provisions of an applicable income tax treaty.
Under current law, backup withholding (which generally is a withholding tax
imposed at the rate of 31% on certain payments to persons that fail to furnish
certain information under the United States information reporting requirements)
generally will not apply to dividends paid to a Non-U.S. Holder at an address
outside the United States (unless the payer has knowledge that the payee is a
U.S. person). Under proposed United States Treasury regulations not currently in
effect, however, a non-US Holder will be subject to back-up withholding unless
applicable certification requirements are met.
Payment of the proceeds of a sale of Common Stock by or through a United
States office of a broker is subject to both backup withholding and information
reporting unless the beneficial owner certifies under penalties of perjury that
it is a non-U.S. Holder, or otherwise establishes an exemption. In general,
backup withholding and information reporting will not apply to a payment of the
proceeds of a sale of Common Stock by or through a foreign office of a broker.
If, however, such broker is, for United States federal income tax purposes a
U.S. person, a controlled foreign corporation, or a foreign person that derives
50% or more of its gross income for certain periods from the conduct of a trade
or business in the United States, such payments will be subject to information
reporting, but not backup withholding, unless (1) such broker has documentary
evidence in its records that the beneficial owner is a Non-U.S. Holder and
certain other conditions are met, or (2) the beneficial owner otherwise
establishes an exemption.
Any amounts withheld under the backup withholding rules may be allowed as a
refund or a credit against such holder's U.S. federal income tax liability
provided the required information is furnished to the IRS.
S-94
<PAGE>
UNDERWRITING
Subject to the terms and conditions set forth in a purchase agreement (the
"U.S. Purchase Agreement"), the Company has agreed to sell to the U.S.
Underwriters named below (the "U.S. Underwriters"), and the U.S. Underwriters,
for whom Merrill Lynch, Pierce, Fenner & Smith Incorporated, Donaldson, Lufkin &
Jenrette Securities Corporation, Salomon Brothers Inc and Dain Bosworth
Incorporated are acting as representatives (the "U.S. Representatives"), have
severally agreed to purchase, the number of shares of Common Stock set forth
opposite their respective names below.
<TABLE>
<CAPTION>
NUMBER OF
U.S. UNDERWRITERS SHARES
------------------------------------------------------------------- ----------
<S> <C> <C>
Merrill Lynch, Pierce, Fenner & Smith
Incorporated....................................................... 675,000
Donaldson, Lufkin & Jenrette Securities Corporation................................ 675,000
Salomon Brothers Inc............................................................... 675,000
Dain Bosworth Incorporated......................................................... 375,000
Dean Witter Reynolds Inc........................................................... 200,000
Goldman, Sachs & Co................................................................ 200,000
J.P. Morgan Securities Inc......................................................... 200,000
Smith Barney Inc................................................................... 200,000
Genesis Merchant Group Securities.................................................. 100,000
Jensen Securities Co............................................................... 100,000
Piper Jaffray Inc.................................................................. 100,000
Ragen MacKenzie Incorporated....................................................... 100,000
----------
Total.............................................................. 3,600,000
----------
----------
</TABLE>
The Company has also entered into a purchase agreement (the "International
Purchase Agreement" and, together with the U.S. Purchase Agreement, the
"Agreements") with certain underwriters outside the United States and Canada
(the "International Managers"), for whom Merrill Lynch International, Donaldson,
Lufkin & Jenrette Securities Corporation, Salomon Brothers International Limited
and Dain Bosworth Incorporated are acting as lead managers (the "International
Representatives"). Subject to the terms and conditions set forth in the
International Purchase Agreement, the Company has agreed to sell to the
International Managers, and the International Managers have severally agreed to
purchase, an aggregate of 900,000 shares of Common Stock. The initial public
offering price per share and the underwriting discount per share are identical
under the U.S. Purchase Agreement and the International Purchase Agreement.
In the U.S. Purchase Agreement and the International Purchase Agreement, the
several U.S. Underwriters and the several International Managers (collectively,
the "Underwriters"), respectively, have agreed, subject to the terms and
conditions set forth therein, to purchase all of the shares of Common Stock
being sold pursuant to such Agreement if any of the shares of Common Stock being
sold pursuant to such Agreement are purchased. The U.S. Purchase Agreement
provides that, in the event of a default by a U.S. Underwriter, the purchase
commitments of the non-defaulting U.S. Underwriters may in certain circumstances
be increased, and the International Purchase Agreement provides that, in the
event of a default by an International Manager, the purchase commitments of the
non-defaulting International Managers may in certain circumstances be increased.
The closing with respect to the sale of the shares of Common Stock pursuant to
the U.S. Purchase Agreement is a condition to the closing with respect to the
sale of the shares of Common Stock pursuant to the International Purchase
Agreement, and the closing with respect to the sale of the shares of Common
Stock pursuant to the International Purchase Agreement is a condition to the
closing with respect to the sale of the shares of Common Stock pursuant to the
U.S. Purchase Agreement. In addition, the closing with respect to the sale of
the shares of Common Stock pursuant to both of the Agreements is contingent upon
the concurrent closing of the Notes Offering, the
S-95
<PAGE>
concurrent effectiveness of the New Credit Facility and the concurrent
consummation of the Hughes Acquisition. See "The Acquisitions."
The U.S. Underwriters and the International Managers have entered into an
intersyndicate agreement (the "Intersyndicate Agreement") which provides for the
coordination of their activities. Under the terms of the Intersyndicate
Agreement, the U.S. Underwriters and the International Managers are permitted to
sell shares of Common Stock to each other. Pursuant to the Intersyndicate
Agreement, sales may be made between the International Managers and the U.S.
Underwriters of such number of shares of Common Stock as may be mutually agreed.
The price of any shares of Common Stock so sold shall be the initial public
offering price, less an amount not greater than the selling concession.
Under the terms of the Intersyndicate Agreement, the U.S. Underwriters and
any dealer to whom they sell shares of Common Stock will agree to offer to sell
or sell shares of Common Stock only to persons whom they believe are United
States Persons or Canadian Persons (as defined in the Intersyndicate Agreement)
or to persons whom they believe intend to reoffer or resell the same to United
States Persons or Canadian Persons, and the International Managers and any bank,
broker or dealer to whom they sell shares of Common Stock will agree not to
offer to sell or sell shares of Common Stock to persons whom they believe to be
United States Persons or Canadian Persons or to persons whom they believe intend
to reoffer or resell the same to United States Persons or Canadian Persons,
except in each case for transactions pursuant to the Intersyndicate Agreement
which, among other things, permits the Underwriters to purchase from each other
and offer for resale such number of shares of Common Stock as the selling
Underwriter or Underwriters and the purchasing Underwriter or Underwriters may
agree.
The U.S. Representatives have advised the Company that the U.S. Underwriters
propose initially to offer the shares of Common Stock offered hereby to the
public at the public offering price set forth on the cover page of this
Prospectus Supplement and to certain dealers at such price less a concession not
in excess of $.98 per share. The U.S. Underwriters may allow, and such dealers
may reallow, a discount not in excess of $.10 per share on sales to certain
other dealers. After the initial public offering, the public offering price,
concession and discount may be changed.
The Company has granted to the U.S. Underwriters an option, exercisable for
30 days after the date hereof, to purchase up to 540,000 additional shares of
Common Stock and to the International Managers an option, exercisable for 30
days after the date hereof, to purchase up to 135,000 additional shares of
Common Stock, in each case solely to cover over-allotments, if any, at the
initial public offering price less the underwriting discount. To the extent that
the U.S. Underwriters exercise this option, each of the U.S. Underwriters will
be obligated, subject to certain conditions, to purchase approximately the same
percentage of such shares which the number of shares of Common Stock to be
purchased by it shown in the foregoing table bears to the total number of shares
of Common Stock set forth in such table.
The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act.
The Company has agreed that, for a period of 90 days from the date of this
Prospectus Supplement, the Company will not, without the prior written consent
of Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch"),
directly or indirectly (i) offer, pledge, sell, contract to sell, sell any
option or contract to purchase, purchase any option or contract to sell, grant
any option, right or warrant to purchase or otherwise transfer or dispose of any
shares of Common Stock or any securities convertible into or exercisable or
exchangeable for Common Stock or file any registration statement under the
Securities Act with respect to the foregoing or (ii) enter into any swap or
other agreement or any transaction that transfers, in whole or in part, directly
or indirectly, the economic consequences of ownership of Common Stock, whether
any such swap or other transaction described in (i) or (ii) above is to be
settled by delivery of Common Stock, other securities, cash or otherwise. The
foregoing sentence shall not apply to (A) the Common Stock to be sold in the
Common Stock Offering, (B) any shares of Common Stock issued by the Company upon
the exercise of any option outstanding on the date of this Prospectus Supplement
or
S-96
<PAGE>
(C) any shares of Common Stock issued or options to purchase Common Stock
granted pursuant to existing employee benefit plans. In addition, Parent has
agreed that, if the Reorganization occurs at any time during the period of 90
days following the date of this Prospectus Supplement, then, during such 90-day
period, Parent will not, without the prior written consent of Merrill Lynch,
directly or indirectly, offer or sell any shares of its common stock on the same
terms as are applicable to the Company.
Zell Chilmark and all of the Company's executive officers and directors have
agreed that, for a period of 90 days from the date of this Prospectus
Supplement, they will not, without the prior written consent of Merrill Lynch,
directly or indirectly (i) offer, pledge, sell, contract to sell, sell any
option or contract to purchase, purchase any option or contract to sell, grant
any option, right or warrant to purchase or otherwise transfer or dispose of any
shares of Common Stock or any securities convertible into or exchangeable or
exercisable for Common Stock, whether owned by them at the date of this
Prospectus Supplement or acquired hereafter or with respect to which any of them
has or hereafter acquires the power of disposition, or file any registration
statement under the Securities Act with respect to any of the foregoing or (ii)
enter into any swap or other agreement or any transaction that transfers, in
whole or in part, directly or indirectly, the economic consequences of ownership
of the Common Stock, whether any such swap or other transaction described in
clause (i) or (ii) above is to be settled by the delivery of Common Stock, other
securities, cash or otherwise.
In addition, the persons who received shares of the Company's Common Stock
in the KUI Acquisition have agreed with the Company that they will not sell or
otherwise dispose of any such shares for a period of 90 days from the date of
this Prospectus Supplement, and the Company has agreed that it will not waive or
modify such agreement without the prior written consent of Merrill Lynch.
Until the distribution of the Common Stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the Underwriters and
certain selling group members to bid for and purchase the Common Stock. As an
exception to these rules, the U.S. Representatives are permitted to engage in
certain transactions that stabilize the price of the Common Stock. Such
transactions consist of bids or purchases for the purpose of pegging, fixing or
maintaining the price of the Common Stock.
If the Underwriters create a short position in the Common Stock in
connection with the offering (i.e., if they sell more shares of Common Stock
than are set forth on the cover page of this Prospectus), the U.S.
Representatives may reduce that short position by purchasing Common Stock in the
open market. The U.S. Representatives may also elect to reduce any short
position through the exercise of all or part of the over-allotment options
described above.
The U.S. Representatives may also impose a penalty bid on certain
Underwriters and selling group members. This means that if the U.S.
Representatives purchase shares of Common Stock in the open market to reduce the
Underwriters' short position or to stabilize the price of the Common Stock, they
may reclaim the amount of the selling concession from the Underwriters and
selling group members who sold those shares as part of the offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of such purchases. The imposition of a penalty bid
might also have an effect on the price of a security to the extent that it were
to discourage resales of the security.
Neither the Company nor any of the Underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the Common Stock. In addition, neither
the Company nor any of the Underwriters makes any representation that the U.S.
Representatives will engage in such transactions or that such transactions, once
commenced, will not be discontinued without notice.
S-97
<PAGE>
LEGAL MATTERS
Certain legal matters relating to the Common Stock Offering made hereby will
be passed upon for the Company by Simpson Thacher & Bartlett (a partnership
which includes professional corporations), New York, New York 10017 in respect
of New York law, and by Bogle & Gates P.L.L.C., Seattle, Washington, in respect
of Washington law. Brown & Wood LLP, San Francisco, California will act as
counsel for the Underwriters.
EXPERTS
The financial statements of Quality Food Centers, Inc. included in this
Prospectus Supplement have been audited by Deloitte & Touche LLP, independent
auditors, as stated in their report appearing herein and are included in
reliance upon the report of such firm given upon their authority as experts in
accounting and auditing.
The consolidated financial statements of Hughes Markets, Inc. included in
this Prospectus Supplement have been audited by Arthur Andersen LLP, independent
public accountants, as indicated in their report with respect thereto, and are
included herein in reliance upon the authority of said firm as experts in giving
said report.
The financial statements of Keith Uddenberg, Inc. incorporated by reference
herein from Quality Food Centers, Inc.'s Current Report on Form 8-K/A dated
February 18, 1997, have been audited by Deloitte & Touche LLP, independent
auditors, as stated in their report which is incorporated herein by reference,
and such financial statements are incorporated by reference herein in reliance
upon the report of such firm given upon their authority as experts in accounting
and auditing.
S-98
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
QUALITY FOOD CENTERS, INC.
Quarterly Financial Statements (Unaudited):
Statements of Earnings for the 36 weeks ended September 7, 1996 and September 9, 1995.................... F-2
Balance Sheets as of September 7, 1996 and December 30, 1995............................................. F-3
Statement of Shareholders' Equity for the 36 weeks ended September 7, 1996............................... F-4
Statements of Cash Flows for the 36 weeks ended September 7, 1996 and September 9, 1995.................. F-5
Notes to Financial Statements for the 36 weeks ended September 7, 1996 and September 9, 1995............. F-6
Audited Financial Statements:
Independent Auditors' Report............................................................................. F-9
Statements of Earnings for each of the three years in the period ended December 30, 1995................. F-10
Statements of Shareholders' Equity for each of the three years in the period ended December 30, 1995..... F-11
Balance Sheets as of December 30, 1995 and December 31, 1994............................................. F-12
Statements of Cash Flows for each of the three years in the period ended December 30, 1995............... F-13
Notes to Financial Statements for each of the three years in the period ended December 30, 1995.......... F-14
HUGHES MARKETS, INC.
Report of Independent Public Accountants................................................................. F-26
Consolidated Balance Sheets as of February 26, 1995, March 3, 1996 and September 29, 1996................ F-27
Consolidated Statements of Income for each of the three years in the period ended March 3, 1996 and for
the seven months ended September 24, 1995 and September 29, 1996....................................... F-28
Consolidated Statements of Shareholders' Equity for each of the three years in the period ended March 3,
1996 and for the seven months ended September 29, 1996................................................. F-29
Consolidated Statements of Cash Flows for each of the three years in the period ended March 3, 1996 and
for the seven months ended September 24, 1995 and September 29, 1996................................... F-30
Notes to Consolidated Financial Statements............................................................... F-31
</TABLE>
F-1
<PAGE>
QUALITY FOOD CENTERS, INC.
STATEMENTS OF EARNINGS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
36 WEEKS ENDED
--------------------------
SEPTEMBER 7, SEPTEMBER 9,
1996 1995
------------ ------------
<S> <C> <C>
Sales................................................................................. $ 547,166 $ 490,534
Cost of sales and related occupancy expenses.......................................... 410,549 369,177
Marketing, general and administrative expenses........................................ 103,850 92,476
------------ ------------
Operating Income...................................................................... 32,767 28,881
Interest income....................................................................... 301 426
Interest expense...................................................................... (6,901) (5,885)
Other expense......................................................................... (1,400)
------------ ------------
Earnings Before Income Taxes.......................................................... 26,167 22,022
Taxes on income
Current............................................................................. 8,413 7,343
Deferred............................................................................ 959 1,010
------------ ------------
Total taxes on income................................................................. 9,372 8,353
------------ ------------
Net Earnings.......................................................................... $ 16,795 $ 13,669
------------ ------------
------------ ------------
Earnings Per Share.................................................................... $ 1.14 $ .83
Weighted average shares outstanding................................................... 14,766 16,401
Dividends per common share............................................................ $ -- $ 0.05
</TABLE>
See accompanying notes to financial statements.
F-2
<PAGE>
QUALITY FOOD CENTERS, INC.
BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 30,
1995
SEPTEMBER 7, ------------
1996
------------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents............................................................ $ 11,570 $ 10,933
Accounts receivable.................................................................. 9,655 9,031
Inventories.......................................................................... 35,670 36,706
Prepaid expenses..................................................................... 6,442 5,524
------------ ------------
Total Current Assets................................................................. 63,337 62,194
Properties
Land................................................................................. 15,025 8,576
Building, fixtures and equipment..................................................... 152,331 132,594
Leasehold improvements............................................................... 43,084 38,767
Construction in progress............................................................. 6,927 15,954
------------ ------------
217,367 195,891
Accumulated depreciation and amortization............................................ (59,878) (48,810)
------------ ------------
157,489 147,081
Leasehold Interest, net of accumulated amortization of $10,719 and $9,535............ 27,382 27,954
Real estate held for investment...................................................... 5,888 5,622
Goodwill, net of accumulated amortization of $1,751 and $1,009....................... 33,857 34,599
Other Assets......................................................................... 5,657 5,428
------------ ------------
$ 293,610 $ 282,878
------------ ------------
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable..................................................................... $ 33,414 $ 34,173
Accrued payroll and related benefits................................................. 13,041 12,556
Accrued business and sales taxes..................................................... 5,260 5,037
Other accrued expenses............................................................... 5,916 4,720
Federal income taxes payable......................................................... 3,709 405
Current portion of long-term debt.................................................... 18,900 --
------------ ------------
Total Current Liabilities............................................................ 80,240 56,891
Deferred Income Taxes................................................................ 11,735 9,992
Other Liabilities.................................................................... 6,128 6,127
Long-Term Debt....................................................................... 131,100 164,500
Shareholders' Equity
Common stock at stated value--authorized 60,000,000 shares, issued and outstanding
14,579,000 shares and 14,432,000 shares............................................ 31,176 28,932
Retained earnings.................................................................... 33,231 16,436
------------ ------------
Total Shareholders' Equity........................................................... 64,407 45,368
------------ ------------
$ 293,610 $ 282,878
------------ ------------
------------ ------------
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE>
QUALITY FOOD CENTERS, INC.
STATEMENT OF SHAREHOLDERS' EQUITY
36 WEEKS ENDED SEPTEMBER 7, 1996
(UNAUDITED)
<TABLE>
<CAPTION>
COMMON STOCK
-------------------- RETAINED
SHARES AMOUNT EARNINGS TOTAL
--------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Balance at December 30, 1995........................................... 14,432 $ 28,932 $ 16,436 $ 45,368
Net Earnings........................................................... -- -- 16,795 16,795
Common Stock Issued.................................................... 147 2,244 -- 2,244
--------- --------- --------- ---------
Balance at September 7, 1996........................................... 14,579 $ 31,176 $ 33,231 $ 64,407
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE>
QUALITY FOOD CENTERS, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THIRTY-SIX WEEKS ENDED
--------------------------
SEPTEMBER 7, SEPTEMBER 9,
1996 1995
------------ ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Operating Activities
Net earnings........................................................................ $ 16,795 $ 13,669
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization of properties....................................... 11,063 8,641
Amortization of leasehold interest and other...................................... 2,526 2,074
Amortization of debt issuance costs............................................... 128 86
Deferred income taxes............................................................. 959 1,010
Changes in Operating Assets and Liabilities:
Accounts receivable................................................................. (624) (1,202)
Inventories......................................................................... 1,036 (1,280)
Prepaid expenses.................................................................... (1,046) (3,224)
Accounts payable.................................................................... (759) (7,250)
Accrued payroll and related benefits................................................ 485 1,778
Accrued business and sales taxes.................................................... 223 935
Other accrued expenses.............................................................. 1,196 1,319
Federal income taxes payable........................................................ 4,088 4,121
------------ ------------
Net Cash Provided by Operating Activities............................................. 36,070 20,677
------------ ------------
Investing Activities:
Capital expenditures, net........................................................... (25,000) (20,780)
Cash portion of Olson's merger...................................................... -- (17,815)
Other............................................................................... (827) (653)
Proceeds from sale of real estate................................................... 2,650 1,340
------------ ------------
Net Cash Used by Investing Activities................................................. (23,177) (37,908)
------------ ------------
Financing Activities:
Proceeds from issuance of common stock.............................................. 2,244 27,045
Common stock repurchased............................................................ -- (177,850)
Net proceeds under revolving credit facility........................................ -- 4,000
Proceeds from (repayments of) long-term debt........................................ (14,500) 140,000
Cash dividend paid.................................................................. -- (974)
------------ ------------
Net Cash Used by Financing Activities................................................. (12,256) (7,779)
------------ ------------
Net Increase (Decrease) in Cash and Cash Equivalents.................................. 637 (25,010)
Cash and Cash Equivalents, Beginning of Period........................................ 10,933 35,163
------------ ------------
Cash and Cash Equivalents, End of Period.............................................. $ 11,570 $ 10,153
------------ ------------
------------ ------------
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE>
QUALITY FOOD CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS
THIRTY-SIX WEEKS ENDED SEPTEMBER 7, 1996 AND SEPTEMBER 9, 1995
(UNAUDITED)
NOTE A--NATURE OF OPERATIONS
Quality Food Centers, Inc. ("QFC") is the second largest supermarket chain
in the Seattle/Puget Sound region of Washington State, and the largest
independent chain in the area. The Company has been in operation since 1954 and
currently operates 62 stores and employs over 4,200 people.
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
FINANCIAL STATEMENT PREPARATION--The financial statements as of and for the
twelve and thirty-six weeks ended September 7, 1996 and September 9, 1995 are
unaudited, but in the opinion of management include all adjustments (consisting
of normal recurring adjustments) necessary to present fairly the financial
position and results of operations and cash flows for the periods presented.
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 dated
March 20, 1996 (File No. 0-15590) for the year ended December 30, 1995 filed
with the SEC on March 29, 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. Accrual 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, and its reporting quarters consist of three 12-weeks quarters and a
16-week fourth quarter.
EARNINGS PER SHARE--Earnings per share are based upon the weighted average
number of common shares and common share equivalents outstanding during the
period.
NOTE C--SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for income taxes and interest expense for the thirty-six weeks
ended September 7, 1996 and September 9, 1995 was as follows (in thousands):
<TABLE>
<CAPTION>
THIRTY-SIX WEEKS ENDED
----------------------------
SEPTEMBER 7, SEPTEMBER 9,
1996 1995
------------- -------------
<S> <C> <C>
Income taxes...................................................... $ 4,325 $ 3,392
Interest (net of interest capitalized of $943 and $68,
respectively).................................................... 6,602 5,422
</TABLE>
F-6
<PAGE>
QUALITY FOOD CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS
THIRTY-SIX WEEKS ENDED SEPTEMBER 7, 1996 AND SEPTEMBER 9, 1995
(UNAUDITED) (CONTINUED)
NOTE C--SUPPLEMENTAL CASH FLOW INFORMATION (CONTINUED)
During the first quarter of 1995, the Company acquired all of the
outstanding shares of Olson's Food Stores, Inc. in a merger transaction for
$60.1 million (Note D). In connection with the merger, consideration provided
was as follows (in thousands):
<TABLE>
<S> <C>
Fair value of assets acquired.................................... $ 69,246
Cash paid........................................................ (18,000)
Long-term debt assumed........................................... (24,000)
Common stock issued.............................................. (18,070)
---------
Current liabilities assumed...................................... $ 9,176
---------
---------
</TABLE>
During the first quarter of 1995, the Company recorded $4.0 million as an
increase in goodwill and deferred income taxes to record deferred income taxes
arising from the Olson's merger. Further, as part of the merger agreement, the
Company agreed to remit the benefits, if any, of Olson's net operating lose
carryforwards totaling approximately $12.0 million and certain other tax credit
carryforwards totally approximately $1.2 million to the former shareholders of
Olson's when utilized. Accordingly, a deferred tax asset and corresponding
liability of $5.4 million were recorded to reflect amounts due the former
shareholders of Olson's when tax loss and tax credit carry forwards are utilized
by the Company. The Company utilized $784,000 of the tax asset during the second
quarter of 1996 and $653,000 of the tax asset during the second quarter of 1995.
NOTE D--OLSON'S MERGER
On March 2, 1995 the principal operations of Olson's Food Stores, Inc. were
merged into the Company, including assets and liabilities related to 12 of its
grocery stores and its interest in certain grocery stores in various stages of
development, and its rights to several other future sites. The merger was
effected through an acquisition of 100% of the outstanding voting securities of
Olson's for $18.0 million cash, 752,941 shares of the Company's common stock,
which as of March 2, 1995 had a value of $18.1 million, and the assumption by
the Company of approximately $24.0 million of indebtedness of Olson's. The
merger has been accounted for under the "purchase" method of accounting.
Goodwill of $32.4 million is being amortized over a period of 35 years.
Because the merger 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.
F-7
<PAGE>
QUALITY FOOD CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS
THIRTY-SIX WEEKS ENDED SEPTEMBER 7, 1996 AND SEPTEMBER 9, 1995
(UNAUDITED) (CONTINUED)
NOTE D--OLSON'S MERGER (CONTINUED)
Following is a summary of the assets and liabilities recorded as a result of
the Olson's merger (in thousands):
<TABLE>
<S> <C>
Cash............................................................... $ 182
Inventories........................................................ 8,541
Other current assets............................................... 453
---------
Total current assets........................................... 9,176
Property plant and equipment (net)................................. 18,087
Leasehold interest................................................. 12,829
Goodwill........................................................... 32,367
Other assets....................................................... 7,487
Current liabilities................................................ (9,176)
Deferred income taxes.............................................. (4,000)
Other liabilities.................................................. (6,700)
---------
$ 60,070
---------
---------
</TABLE>
NOTE E--RECAPITALIZATION
During the second quarter of 1995, the Company completed a recapitalization.
The Company's self-tender offer that commenced on January 18, 1995, for up to
7.0 million shares of its common stock at a price of $25.00 per share payable in
cash expired on March 17, 1995. On March 29, 1995, the Company purchased 7.0
million shares of its common stock and entered into a new $220.0 million credit
facility to finance the tender offer, Olson's merger, and provide additional
capital. Additionally, the Company sold 1.0 million newly issued shares of its
common stock to Zell/Chilmark Fund LP (Zell/Chilmark) at $25.00 per share on
March 29, 1995. Zell/Chilmark acquired 2,975,000 additional shares at $25.00 per
share, plus an amount equal to a 5% annual return on such amount from March 17,
1995 through January 16, 1996, directly from the Company's chairman and chief
executive officer in a separate transaction that closed on January 16, 1996.
To reflect the net reduction in shareholders' equity resulting from the
recapitalization, the Company reduced retained earnings to zero at the beginning
of the second quarter of 1995 and allocated the remaining amount as a reduction
to common stock.
Fees paid in connection with the recapitalization aggregated approximately
$4.3 million. During the first quarter of 1995, $1.4 million of these fees were
recorded as a one-time expense, which is not deductible for federal income tax
purposes. The remaining costs of $2.9 million were recorded as a direct
reduction to shareholders' equity.
F-8
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Quality Food Centers, Inc.
Bellevue, Washington
We have audited the accompanying balance sheets of Quality Food Centers,
Inc. as of December 30, 1995 and December 31, 1994, and the related statements
of earnings, shareholders' equity, and cash flows for each of the three years in
the period ended December 30, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of Quality Food Centers, Inc. as of December
30, 1995 and December 31, 1994, and the results of its operations and its cash
flows for each of the three years in the period ended December 30, 1995, in
conformity with generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
March 20, 1996
Seattle, Washington
F-9
<PAGE>
QUALITY FOOD CENTERS, INC.
STATEMENTS OF EARNINGS
YEARS ENDED DECEMBER 30, 1995, DECEMBER 31, 1994,
AND DECEMBER 25, 1993
<TABLE>
<CAPTION>
1995 1994 1993
-------------- -------------- --------------
<S> <C> <C> <C>
Sales........................................................... $ 729,855,999 $ 575,878,589 $ 518,259,868
Cost of sales and related occupancy expenses.................... 550,434,224 430,711,080 386,895,474
Marketing, general and administrative expenses.................. 136,644,381 105,955,569 92,467,509
-------------- -------------- --------------
Operating income................................................ 42,777,394 39,211,940 38,896,885
Interest income................................................. 501,249 932,596 879,687
Interest expense................................................ 9,639,405 -- --
Other expense................................................... 1,400,000 -- --
-------------- -------------- --------------
Earnings before income taxes.................................... 32,239,238 40,144,536 39,776,572
Taxes on income:
Current....................................................... 10,087,000 11,593,000 11,207,000
Deferred...................................................... 1,936,000 2,175,000 2,576,000
-------------- -------------- --------------
Total taxes on income........................................... 12,023,000 13,768,000 13,783,000
-------------- -------------- --------------
Net earnings.................................................... $ 20,216,238 $ 26,376,536 $ 25,993,572
-------------- -------------- --------------
-------------- -------------- --------------
Earnings per share.............................................. $ 1.28 $ 1.34 $ 1.33
Weighted average shares outstanding............................. 15,830,000 19,656,000 19,592,000
Dividends per common share...................................... $ .05 $ .20 $ .15
</TABLE>
See notes to financial statements.
F-10
<PAGE>
QUALITY FOOD CENTERS, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 30, 1995,
DECEMBER 31, 1994, AND
DECEMBER 25, 1993
<TABLE>
<CAPTION>
COMMON STOCK
--------------------------- RETAINED
SHARES AMOUNT EARNINGS TOTAL
------------ ------------- -------------- --------------
<S> <C> <C> <C> <C>
Balance at December 26, 1992........................ 19,233,684 $ 22,395,240 $ 85,950,068 $ 108,345,308
Net earnings........................................ -- -- 25,993,572 25,993,572
Common stock issued................................. 115,463 1,980,582 -- 1,980,582
Tax benefit related to stock options................ -- 199,829 -- 199,829
Cash dividends ($.15 per share)..................... -- -- (2,899,049) (2,899,049)
------------ ------------- -------------- --------------
Balance at December 25, 1993........................ 19,349,147 24,575,651 109,044,591 133,620,242
Net earnings........................................ -- -- 26,376,536 26,376,536
Common stock issued................................. 131,862 1,992,900 -- 1,992,900
Tax benefit related to stock options................ -- 76,065 -- 76,065
Cash dividends ($.20 per share)..................... -- -- (3,887,905) (3,887,905)
------------ ------------- -------------- --------------
Balance at December 31, 1994........................ 19,481,009 26,644,616 131,533,222 158,177,838
Net earnings........................................ -- -- 20,216,238 20,216,238
Common stock issued................................. 1,951,119 45,130,515 -- 45,130,515
Common stock repurchased (including offering fees
and expenses aggregating $2,849,947).............. (7,000,000) (43,510,084) (134,339,863) (177,849,947)
Tax benefit related to stock options................ -- 666,987 -- 666,987
Cash dividend ($.05 per share)...................... -- -- (974,050) (974,050)
------------ ------------- -------------- --------------
Balance at December 30, 1995........................ 14,432,128 $ 28,932,034 $ 16,435,547 $ 45,367,581
------------ ------------- -------------- --------------
------------ ------------- -------------- --------------
</TABLE>
See notes to financial statements.
F-11
<PAGE>
QUALITY FOOD CENTERS, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 30, DECEMBER 31,
1995 1994
-------------- --------------
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents........................................................ $ 10,932,711 $ 35,162,625
Accounts receivable.............................................................. 9,031,239 3,285,717
Inventories...................................................................... 36,706,259 23,615,073
Prepaid expenses................................................................. 5,523,611 2,645,579
-------------- --------------
Total Current Assets............................................................. 62,193,820 64,708,994
Properties
Land............................................................................. 8,576,024 9,721,225
Buildings, fixtures and equipment................................................ 132,594,371 96,096,154
Leasehold improvements........................................................... 38,766,871 32,577,792
Construction in progress......................................................... 15,953,743 --
-------------- --------------
195,891,009 138,395,171
Accumulated depreciation and amortization........................................ (48,810,330) (36,095,273)
-------------- --------------
147,080,679 102,299,898
Leasehold interest, net of accumulated amortization of $9,534,637 and
$7,946,985..................................................................... 27,953,998 16,133,654
Real estate held for investment.................................................. 5,622,756 19,166,054
Goodwill, net of accumulated amortization of $1,008,745 and $136,137............. 34,598,787 2,185,369
Other assets..................................................................... 5,428,115 3,419,633
-------------- --------------
$ 282,878,155 $ 207,913,602
-------------- --------------
-------------- --------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable................................................................. $ 34,173,236 $ 24,043,452
Accrued payroll and related benefits............................................. 12,555,638 9,941,414
Accrued business and sales taxes................................................. 5,036,853 3,915,494
Other accrued expenses........................................................... 4,720,079 2,692,404
Federal income taxes payable..................................................... 405,000 340,000
-------------- --------------
Total Current Liabilities........................................................ 56,890,806 40,932,764
Deferred income taxes............................................................ 9,992,000 8,803,000
Other liabilities................................................................ 6,127,768 --
Long-term debt................................................................... 164,500,000 --
Shareholders' Equity
Common stock, at stated value--
Authorized 60,000,000 shares Issued and outstanding 14,432,128 shares and
19,481,009 shares.......................................................... 28,932,034 26,644,616
Retained earnings................................................................ 16,435,547 131,533,222
-------------- --------------
Total Shareholders' Equity....................................................... 45,367,581 158,177,838
-------------- --------------
$ 282,878,155 $ 207,913,602
-------------- --------------
-------------- --------------
</TABLE>
See notes to financial statements.
F-12
<PAGE>
QUALITY FOOD CENTERS, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 30, 1995, DECEMBER 31, 1994,
AND DECEMBER 25, 1993
<TABLE>
<CAPTION>
1995 1994 1993
--------------- -------------- --------------
<S> <C> <C> <C>
Operating Activities:
Net earnings.................................................. $ 20,216,238 $ 26,376,536 $ 25,993,572
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Depreciation and amortization of properties................. 12,892,275 10,130,395 8,040,474
Amortization of leasehold interest and other................ 3,277,506 1,474,404 1,242,383
Amortization of debt issuance fees.......................... 142,609 -- --
Deferred income taxes....................................... 1,936,000 2,175,000 2,576,000
Changes in operating assets and liabilities:
Accounts receivable......................................... (5,292,349) (506,700) 164,327
Inventories................................................. (4,550,186) (4,185,146) (3,587,343)
Prepaid expenses............................................ (2,878,032) (755,442) (327,116)
Accounts payable............................................ 297,137 (35,120) 1,751,063
Accrued payroll and related benefits........................ 2,614,224 481,610 603,201
Accrued business and sales taxes............................ 1,121,359 727,172 406,122
Other accrued expenses...................................... 2,108,396 (1,066,647) 258,027
Federal income taxes payable................................ 1,384,987 (201,000) (568,000)
--------------- -------------- --------------
Net Cash Provided by Operating Activities....................... 33,270,164 34,615,062 36,552,710
--------------- -------------- --------------
Investing Activities:
Capital expenditures, net..................................... (28,638,585) (20,983,065) (39,864,618)
Cash portion of Olson's merger................................ (18,000,000) -- --
Increase in real estate held for investment................... (406,674) (7,196,079) (3,156,420)
Other......................................................... (531,337) (710,845) 1,493,830
Proceeds from sale of real estate............................. 1,340,000 -- --
--------------- -------------- --------------
Net Cash Used by Investing Activities........................... (46,236,596) (28,889,989) (41,527,208)
--------------- -------------- --------------
Financing Activities:
Proceeds from issuances of common stock....................... 27,060,515 2,068,965 2,180,411
Common stock repurchased...................................... (177,849,947) -- --
Net proceeds under revolving credit facility.................. 500,000 -- --
Proceeds from long-term debt.................................. 140,000,000 -- --
Cash dividends paid........................................... (974,050) (3,887,905) (2,899,049)
--------------- -------------- --------------
Net Cash Used by Financing Activities........................... (11,263,482) (1,818,940) (718,638)
--------------- -------------- --------------
Net Increase (Decrease) in Cash and Cash Equivalents............ (24,229,914) 3,906,133 (5,693,136)
Cash and Cash Equivalents, Beginning of Period.................. 35,162,625 31,256,492 36,949,628
--------------- -------------- --------------
Cash and Cash Equivalents, End of Period........................ $ 10,932,711 $ 35,162,625 $ 31,256,492
--------------- -------------- --------------
--------------- -------------- --------------
</TABLE>
See notes to financial statements.
F-13
<PAGE>
QUALITY FOOD CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 30, 1995, DECEMBER 31, 1994 AND DECEMBER 25, 1993
NOTE A
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations--Quality Food Centers, Inc. (QFC) is the second largest
supermarket chain in the Seattle/Puget Sound region of Washington State, and the
largest independent chain in the area. The Company has been in operation since
1954 and currently operates 62 stores and employs over 4,200 people.
Basis of Presentation--The Company's financial statements are prepared in
conformity with generally accepted accounting principles which 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 period. Actual results could differ from the
estimates.
Earnings Per Share--Earnings per share is based upon the weighted average
number of common shares and common share equivalents outstanding during the
period.
Fiscal Year--The Company's fiscal year ends on the last Saturday in
December. The years ended December 30, 1995 and December 25, 1993 represent
52-week fiscal years. The year ended December 31, 1994 was a 53-week fiscal
year.
Cash and Cash Equivalents--The Company considers all highly liquid
investments with a maturity of three months or less at the time of purchase to
be cash equivalents. The Company's investment portfolio is diversified and
consists of investment grade securities, recorded at cost which approximates
market value.
The Company's cash management system provides for reimbursement of bank
disbursement accounts on a daily basis. Checks issued but not presented for
payment to the bank in the aggregate amount of $18,082,833 and $13,004,480 at
December 30, 1995 and December 31, 1994, are included in accounts payable.
Construction in Progress--Costs associated with acquiring land, buildings,
fixtures and equipment while a store is under construction are recorded as
construction in progress. Additionally, the Company capitalizes interest on debt
incurred during the construction of a new store. When a store opens, all costs
are then transferred to the appropriate property account.
Depreciation and Amortization--Depreciation is provided on the straight-line
method over the shorter of the estimated useful lives or 31 1/2 years for
buildings and three to ten years for fixtures and equipment. Amortization of
leasehold improvements is computed on the straight-line method over the term of
the lease or useful life of the assets, whichever is shorter.
Goodwill--Goodwill arises primarily from business acquisitions and
represents the cost of purchased businesses in excess of amounts assigned to
tangible and identified intangible assets. Goodwill is being amortized over
estimated lives of up to 40 years.
Long-lived Assets--The Company periodically reviews long-lived assets,
including identified intangible assets and goodwill for impairment to determine
whether events or changes in circumstances indicate that the carrying amount of
the assets may not be recoverable. Such review includes estimating expected
future cash flows. No such events or circumstances have occurred during 1995.
F-14
<PAGE>
QUALITY FOOD CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 30, 1995, DECEMBER 31, 1994 AND DECEMBER 25, 1993
(CONTINUED)
Start-up and Promotional Expenses--Costs incurred in connection with the
start-up and promotion of new store openings and major store remodels are
expensed as incurred.
Leasehold Interest--Leasehold interests from acquired operating lease rights
are amortized over the term of the respective leases, including renewal periods
exercisable at the option of the Company. Management believes that exercise of
renewal options is probable.
Real Estate Held for Investment--Real estate held for investment includes
land and buildings the Company has acquired where it plans to either operate a
store in the future or sell the real estate, and is recorded at the lower of
cost or market. Upon commencement of construction, costs are transferred to
construction in progress.
Reclassifications--Certain prior years' balances have been reclassified to
conform to classifications used in the current year.
NOTE B
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for income taxes and interest expense for the last three years was
as follows:
<TABLE>
<CAPTION>
1995 1994 1993
------------ ------------- -------------
<S> <C> <C> <C>
Income taxes......................................................... $ 8,872,000 $ 11,718,000 $ 11,576,000
Interest (net of $166,959 of interest capitalized)................... 9,328,328 -- --
------------ ------------- -------------
------------ ------------- -------------
</TABLE>
During the first quarter of 1995, the Company acquired all of the
outstanding shares of Olson's Food Stores, Inc. in a merger transaction for
$60,070,000 (Note K). In connection with the merger, liabilities assumed were as
follows:
<TABLE>
<S> <C>
Fair value of assets acquired.................................. $69,246,000
Cash paid...................................................... (18,000,000)
Long-term debt assumed......................................... (24,000,000)
Common stock issued............................................ (18,070,000)
----------
Current liabilities assumed.................................... $9,176,000
----------
----------
</TABLE>
During the first quarter of 1995 the Company recorded $4,000,000 as an
increase in goodwill and deferred income taxes payable to record deferred income
taxes arising from the Olson's merger. In addition, a deferred tax asset and
corresponding liability of $5,400,000 were recorded to reflect amounts due the
former shareholders of Olson's when tax loss and tax credit carryforwards are
utilized by the Company. During 1995, the Company utilized $653,000 of the tax
asset to reduce current taxes payable.
NOTE C
INVENTORIES
Substantially all merchandise inventories are valued at the lower of
last-in, first-out (LIFO) cost or market. The LIFO method results in a better
matching of costs and revenues, as current merchandise cost is recognized in
cost of merchandise sold instead of in ending inventories as is the practice
under the first-
F-15
<PAGE>
QUALITY FOOD CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 30, 1995, DECEMBER 31, 1994 AND DECEMBER 25, 1993
(CONTINUED)
NOTE C (CONTINUED)
in, first-out (FIFO) method. Information related to the FIFO method may be
useful in comparing operating results to those of companies not on LIFO.
On a supplemental basis, if inventories had been valued at the lower of FIFO
cost or market, inventories would have increased by $1,984,000 and $1,365,000 as
of December 30, 1995 and December 31, 1994, and net earnings would have
increased by $402,000 in 1995 and $16,000 in 1993. There was no LIFO adjustment
in 1994.
NOTE D
LEASES
The Company leases its administrative offices and 57 of its 62 store
facilities in operation under noncancelable operating leases expiring through
2023. Certain of the leases include renewal provisions at the Company's option.
Minimum rental commitments under noncancelable leases, which exclude stores to
be added in 1996, as of December 30, 1995, are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER
- ------------------------------------------------------------------------------
<S> <C>
1996.......................................................................... $ 14,031,600
1997.......................................................................... 13,817,300
1998.......................................................................... 13,631,300
1999.......................................................................... 13,391,100
2000.......................................................................... 13,415,800
Thereafter.................................................................... 166,611,900
--------------
$ 234,899,000
--------------
--------------
</TABLE>
A majority of the store facility leases provide for contingent rentals based
upon specified percentages of sales, real estate tax escalation clauses and
executory costs. Space in several store facilities has been sublet.
A summary of rental expense under operating leases is as follows:
<TABLE>
<CAPTION>
1995 1994 1993
------------- ------------- -------------
<S> <C> <C> <C>
Minimum rent........................................................ $ 12,417,234 $ 8,184,998 $ 7,170,043
Contingent rentals.................................................. 1,820,196 1,744,072 1,989,793
Real estate taxes and executory costs............................... 3,565,656 2,321,142 2,029,980
Less sublease rentals............................................... (569,636) (164,263) (161,030)
------------- ------------- -------------
$ 17,233,450 $ 12,085,949 $ 11,028,786
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
F-16
<PAGE>
QUALITY FOOD CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 30, 1995, DECEMBER 31, 1994 AND DECEMBER 25, 1993
(CONTINUED)
NOTE E
FEDERAL INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes and result from
differences in the timing of recognition of revenue and expenses for tax and
financial statement reporting. The tax effects of significant items comprising
the Company's deferred tax liability as of December 30, 1995 and December 31,
1994 are as follows:
<TABLE>
<CAPTION>
1995 1994
------------- -------------
<S> <C> <C>
DEFERRED TAX ASSETS:
Compensated absences........................................... $ 834,000 $ 750,000
Self insurance................................................. 321,000 388,000
Other.......................................................... 793,000 688,000
Deferred tax asset arising from Olson's merger
(Note K)..................................................... 4,747,000 --
------------- -------------
6,695,000 1,826,000
------------- -------------
DEFERRED TAX LIABILITIES:
Accelerated depreciation....................................... 11,338,000 9,813,000
Multi-employer pension contribution............................ 724,000 558,000
Deferred tax liability arising from Olson's merger
(Note K)..................................................... 4,000,000 --
Other.......................................................... 625,000 258,000
------------- -------------
16,687,000 10,629,000
------------- -------------
Net deferred tax liability..................................... $ 9,992,000 $ 8,803,000
------------- -------------
------------- -------------
</TABLE>
No valuation allowance was necessary for the deferred tax assets at December
30, 1995 and December 31, 1994.
The differences between the Company's effective income tax rates and the
federal statutory rates are summarized as follows:
<TABLE>
<CAPTION>
1995 1994 1993
--------- --------- ---------
<S> <C> <C> <C>
Statutory rate....................................................................... 35.0% 35.0% 35.0%
Nondeductible goodwill............................................................... .9 -- --
Nondeductible recapitalization fees.................................................. 1.6 -- --
Other (primarily interest on tax-free municipal securities).......................... (.2) (.7) (.7)
Revaluation of deferred tax liability due to tax rate change......................... -- -- .4
--- --- ---
Effective tax rate................................................................... 37.3% 34.3% 34.7%
--- --- ---
--- --- ---
</TABLE>
F-17
<PAGE>
QUALITY FOOD CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 30, 1995, DECEMBER 31, 1994 AND DECEMBER 25, 1993
(CONTINUED)
NOTE F
LONG-TERM DEBT
In March 1995, the Company entered into a $220,000,000 credit facility to
finance the repurchase of its shares pursuant to a self-tender offer (Note L)
and to finance a portion of the Olson's merger (Note K). The credit facility
consists of a term loan of $140,000,000 and revolving credit loans of up to
$80,000,000.
Principal repayments of the term loan are due in quarterly installments from
March 1997 through September 2001. The revolving loans are available on a
revolving credit basis for general corporate purposes and any outstanding
amounts would become due in September 2001. At the Company's option, the
interest rate per annum applicable to the credit facility is either (1) the
greater of the bank agent's reference rate or .5% above the federal funds rate
or (2) IBOR plus a margin of 1.25% initially, with margin reductions if the
Company meets specified financial ratios. At December 30, 1995, the borrowings
under the credit facility bore interest at an average rate of approximately
7.0%. Additionally, the credit facility requires a commitment fee of .37% on the
average daily unused portion of the revolving credit loans, computed on a
quarterly basis in arrears.
The credit facility contains a number of significant covenants that, among
other things, restrict the ability of the Company to incur additional
indebtedness or incur liens on its assets, in each case subject to specified
exceptions, impose specified financial tests as a precondition to the Company's
acquisition of other businesses, prohibit the Company from making certain
restricted payments (including dividends) and restrict the Company from making
share repurchases above certain amounts before January 1, 1997 and, subject to
specified financial tests, restrict its ability to make such payments and
repurchases thereafter. In addition, the Company is required to comply with
specified financial ratios and tests, including a maximum debt to cash flow
ratio, minimum ratios of cash flow to fixed charges, a minimum accounts payable
to inventory ratio and a minimum net worth test. The credit facility is secured
by a lien on all of the Company's receivables and intangible assets. The
carrying amount of this debt approximates fair market value, as rates are
approximately equal to those currently available to the Company for similar
purposes.
As of December 30, 1995, long-term debt matures as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER
- ------------------------------------------------------------------------------
<S> <C>
1996.......................................................................... $ --
1997.......................................................................... 25,200,000
1998.......................................................................... 25,200,000
1999.......................................................................... 29,400,000
2000.......................................................................... 35,000,000
Thereafter.................................................................... 49,700,000
--------------
$ 164,500,000
--------------
--------------
</TABLE>
F-18
<PAGE>
QUALITY FOOD CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 30, 1995, DECEMBER 31, 1994 AND DECEMBER 25, 1993
(CONTINUED)
NOTE G
COMMITMENTS AND CONTINGENCIES
The Company is involved in various matters of litigation, all arising in the
ordinary course of business. In the opinion of management, the ultimate outcome
of such matters will not have a material adverse effect on the financial
position or results of operations of the Company.
NOTE H
RELATED PARTY TRANSACTIONS
Pursuant to an agreement with its chairman and chief executive officer, the
Company pays a management fee of up to 0.2% of sales as compensation for
management advisory services. The Company does not pay a salary or bonus to its
chairman and chief executive officer. Management fee expense under the agreement
for 1995, 1994 and 1993 was $981,068, $1,151,757 and $1,036,520. During the
fourth quarter of 1995, in lieu of the management fee, which would have been
approximately $479,000, the Company granted stock options for 58,900 shares of
its stock under the Company's 1993 Executive Stock Option Plan (Note J) to its
chairman and chief executive officer.
In August 1993, two partnerships which include the Company's chairman and
chief executive officer acquired the 24-acre University Village Shopping Center,
where one of the Company's stores is located and which is adjacent to the 8.8
acre parcel of land the Company acquired in 1991. In connection with the
transaction, the Company negotiated with the partnerships for certain property
rights and lease modifications, which among other rights, provide the Company
with the right to be the exclusive grocery store in the center, the right to
relocate its store and a lease term extension of 15 years. The Company paid
$4,960,000 for these rights, which is included in Leasehold Interest and is
being amortized over the life of the lease. Rentals and common area and real
estate tax reimbursements paid to the partnerships were at the same rates paid
to the previous owner of the center and totaled approximately $683,000, $715,000
and $244,000 for 1995, 1994 and 1993.
During 1995, the Company assumed a lease for one of its stores included in
the Olson's merger (Note K) where the landlord is an entity that is controlled
by a member of the Company's Board of Directors. Rental payments for the store,
which include reimbursements for common area maintenance and real estate taxes,
totaled $142,000 during 1995. The lease terminates in April 2001, with options
to renew through April 2035. In addition, during 1995 the Company purchased
approximately $1,673,000 of products from an entity owned by certain family
members of the same member of its Board of Directors.
The Company's president is a member of the board of directors of the
Associated Grocers, Inc. (A.G.) cooperative, which became one of the Company's
major suppliers in 1995. Amounts paid to A.G. for products and services totaled
$44,903,000 for 1995.
F-19
<PAGE>
QUALITY FOOD CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 30, 1995, DECEMBER 31, 1994 AND DECEMBER 25, 1993
(CONTINUED)
NOTE I
RETIREMENT PLANS
The Company participates in a union administered multi-employer defined
benefit pension plan for employees covered by collective bargaining agreements.
The contributions under this plan were $3,067,232, $2,386,971 and $2,166,699 for
1995, 1994 and 1993.
The Company's defined contribution profit-sharing plan includes employees
not covered by collective bargaining agreements who meet certain service
requirements. Contributions to the plan are based on a percentage of gross wages
and are made at the discretion of the Company. The Company's profit-sharing
expense was $548,000, $467,000 and $372,000 for 1995, 1994 and 1993.
The Company maintains a voluntary defined contribution retirement plan
qualified under Section 401(k) of the Internal Revenue Code of 1986, available
to all eligible employees not covered by collective bargaining agreements. The
Company does not currently match employee contributions to the plan.
NOTE J
SHAREHOLDERS' EQUITY
In March 1987, the Company adopted an Incentive Stock Option Plan, under
which options vest ratably over five years and expire after 10 years from the
date of grant. In December 1989, the Company adopted its Directors' Nonqualified
Stock Option Plan for non-employee (non-affiliated) directors of the Company,
under which nonqualified options vest ratably over three years and expire, with
certain exceptions, ten years after the date of grant. In 1993, the Company's
shareholders approved the 1993 Executive Stock Option Plan, under which
nonqualified options vest ratably over five years and expire after 10 years. For
all the plans, the exercise price must not be less than the fair market value of
the common stock at the date of grant.
These plans provide for the grant of options to acquire up to 2,300,000
shares of common stock to officers, directors and employees. Options for
1,365,778 shares granted to 692 employees and four
F-20
<PAGE>
QUALITY FOOD CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 30, 1995, DECEMBER 31, 1994 AND DECEMBER 25, 1993
(CONTINUED)
NOTE J (CONTINUED)
directors were outstanding at December 30, 1995. Stock option activity under
these plans for the last three years was as follows:
<TABLE>
<CAPTION>
NUMBER OPTION PRICE
OF SHARES PER SHARE
---------- ---------------------
<S> <C> <C>
Outstanding, December 26, 1992................................................ 686,490 $3.25 to $34.00
Granted....................................................................... 205,800 25.50 to 32.75
Forfeited..................................................................... (3,930) 6.06 to 34.00
Exercised..................................................................... (54,841) 3.25 to 31.38
---------- ---------------------
Outstanding, December 25, 1993................................................ 833,519 3.25 to 34.00
Granted....................................................................... 204,200 21.00 to 22.75
Forfeited..................................................................... (11,610) 6.06 to 34.00
Exercised..................................................................... (40,656) 3.25 to 17.25
---------- ---------------------
Outstanding, December 31, 1994................................................ 985,453 3.25 to 34.00
Granted....................................................................... 514,950 20.125 to 24.125
Forfeited..................................................................... (20,730) 17.25 to 34.00
Exercised..................................................................... (113,895) 3.25 to 22.50
---------- ---------------------
Outstanding, December 30, 1995................................................ 1,365,778 $3.25 to $34.00
---------- ---------------------
---------- ---------------------
Exercisable, December 30, 1995................................................ 582,089 $3.25 to $34.00
---------- ---------------------
</TABLE>
In 1990, the Company adopted an Employee Stock Purchase Plan under which
500,000 shares of the Company's common stock are reserved for issuance to
employees. Employees are eligible to participate through payroll deductions in
amounts related to their basic compensation. At the end of each offering period,
shares are purchased by the participants at 85% of the lower of the fair market
value at the beginning or the end of the offering period. Under the plan,
84,283, 91,206 and 60,622 shares were issued to 956, 1,061 and 1,088 employees,
in 1995, 1994 and 1993. As of December 30, 1995, payroll deductions totaling
$1,357,000 on behalf of approximately 1,268 employees were accrued for purchase
of shares on March 31, 1996.
Statement of Financial Accounting Standard (SFAS) No. 123, "Accounting for
Stock-Based Compensation," was recently issued and is effective for the
Company's fiscal year ending December 28, 1996. The Company, as allowed, intends
to continue to measure stock-based compensation using its current method of
accounting prescribed by Accounting Principles Board (APB) Opinion No. 25. The
Company will be required to disclose certain additional information related to
its stock options and Employee Stock Purchase Plan; however, management believes
the impact to the financial statements, taken as a whole, will not be material.
F-21
<PAGE>
QUALITY FOOD CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 30, 1995, DECEMBER 31, 1994 AND DECEMBER 25, 1993
(CONTINUED)
NOTE K
OLSON'S MERGER
On March 2, 1995 the principal operations of Olson's Food Stores, Inc. were
merged into the Company, including assets and liabilities related to 12 of its
grocery stores and its interest in certain grocery stores in various stages of
development, and its rights to several other future sites.
The merger was effected through an acquisition of 100% of the outstanding
voting securities of Olson's for $18,000,000 cash, 752,941 shares of the
Company's common stock, which as of March 2, 1995 had a value of $18,070,000,
and the assumption by the Company of approximately $24,000,000 of indebtedness
of Olson's. The merger has been accounted for under the "purchase" method of
accounting.
Goodwill of $32,367,000 is being amortized over a period of 35 years.
Because the merger 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.
The Company has recorded $4,000,000 to goodwill and deferred income taxes to
give effect to deferred income taxes arising from the Olson's merger. Further,
as part of the merger agreement, the Company agreed to remit the benefits, if
any, of Olson's net operating loss carryforwards totaling approximately
$12,000,000 and certain other tax credit carryforwards totaling approximately
$1,200,000 to the former shareholders of Olson's when utilized. A deferred tax
asset and a corresponding liability of $5,400,000 related to these carryforward
items were recorded in the Company's financial statements. During 1995, the
Company utilized $653,000 of the tax asset to reduce current taxes payable.
Following is a summary of the assets and liabilities recorded as a result of
the Olson's merger:
<TABLE>
<S> <C>
Cash........................................................... $ 182,000
Inventories.................................................... 8,541,000
Other Current Assets........................................... 453,000
----------
Total Current Assets..................................... 9,176,000
Property Plant and Equipment (net)............................. 18,087,000
Leasehold Interest............................................. 12,829,000
Goodwill....................................................... 32,367,000
Other Assets................................................... 7,487,000
Current Liabilities............................................ (9,176,000)
Deferred Income Taxes.......................................... (4,000,000)
Other Liabilities.............................................. (6,700,000)
----------
$60,070,000
----------
----------
</TABLE>
The $24,000,000 in long-term debt assumed in connection with the Olson's
merger was partially repaid with cash and partially refinanced with $15,000,000
in borrowings under the Company's credit facility.
Pursuant to the merger agreement, the former shareholders of Olson's are
required to pay to the Company the excess of Olson's current liabilities over
current assets as of the merger date. Such amount totalled $10,216,000, of which
$2,539,000 remained payable to the Company at December 30, 1995.
F-22
<PAGE>
QUALITY FOOD CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 30, 1995, DECEMBER 31, 1994 AND DECEMBER 25, 1993
(CONTINUED)
NOTE L
RECAPITALIZATION
During the second quarter of 1995, the Company successfully completed its
recapitalization plan announced in December 1994. The Company's self-tender
offer that commenced on January 18, 1995, for up to 7,000,000 shares of its
common stock at a price of $25.00 per share payable in cash expired on March 17,
1995. On March 29, 1995, the Company purchased 7,000,000 shares of its common
stock and entered into a new $220,000,000 credit facility to finance the tender
offer, Olson's merger and provide additional capital. Additionally, the Company
sold 1,000,000 newly issued shares of its common stock to Zell/ Chilmark Fund
L.P. (Zell/Chilmark) at $25.00 per share on March 29, 1995. Zell/Chilmark
acquired an additional 2,975,000 shares at $25.00 per share, plus an amount
equal to a 5% annual return on such amount from March 17, 1995 through January
16, 1996, directly from the Company's chairman and chief executive officer in a
separate transaction that closed on January 16, 1996.
To reflect the net reduction in shareholders' equity resulting from the
recapitalization, the Company reduced retained earnings to zero at the beginning
of the second quarter of 1995 and allocated the remaining amount as a reduction
to common stock.
Fees payable in connection with the recapitalization aggregated
approximately $4,250,000. During the first quarter of 1995, $1,400,000 of these
fees were recorded as a one-time expense, which is not deductible for federal
income tax purposes. The remaining costs of $2,849,947 were recorded as a direct
reduction to shareholders' equity.
NOTE M
PRO FORMA FINANCIAL INFORMATION (UNAUDITED)
The following pro forma financial information sets forth historical
information which has been adjusted to reflect the Olson's merger and the
recapitalization described in Notes K and L. The pro forma information is
presented as of and for the year ended December 31, 1994. Olson's historical
information is as of and for the year ended October 29, 1994. The pro forma
statement of earnings information assumes the transactions have taken place at
the beginning of the period presented, while the pro forma balance sheet
information assumes the transactions have occurred on December 31, 1994.
CONDENSED STATEMENTS OF EARNINGS INFORMATION
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA ADJUSTMENTS PRO FORMA
DEC. 31, -------------------------- DEC. 31,
1994 OLSON'S OLSON'S RECAPITALIZATION 1994
------------ ---------- --------- --------------- ------------
<S> <C> <C> <C> <C> <C>
Sales......................................... $ 575,879 $ 112,098 $ -- $ -- $ 687,977
Net earnings.................................. 26,376 3,685 (2,591) (7,937) 19,533
Earnings per share............................ 1.34 N/A -- -- 1.36
Weighted average shares outstanding........... 19,656 N/A 753 (6,000) 14,409
</TABLE>
F-23
<PAGE>
QUALITY FOOD CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 30, 1995, DECEMBER 31, 1994 AND DECEMBER 25, 1993
(CONTINUED)
NOTE M (CONTINUED)
CONDENSED BALANCE SHEET INFORMATION (IN THOUSANDS)
<TABLE>
<CAPTION>
PRO FORMA ADJUSTMENTS PRO FORMA
DEC. 31, --------------------------- DEC. 31,
1994 OLSON'S OLSON'S RECAPITALIZATION 1994
------------ --------- ---------- --------------- ------------
<S> <C> <C> <C> <C> <C>
Current assets............................... $ 64,709 $ 7,694 $ (18,000) $ (5,500) $ 48,903
Property, plant and equipment................ 102,300 16,721 -- -- 119,021
Other assets................................. 40,905 961 42,388 1,200 85,454
------------ --------- ---------- --------------- ------------
$ 207,914 $ 25,376 $ 24,388 $ (4,300) $ 253,378
------------ --------- ---------- --------------- ------------
------------ --------- ---------- --------------- ------------
Current liabilities.......................... $ 40,933 $ 7,694 $ -- $ -- $ 48,627
Long-term debt............................... -- 6,583 17,417 150,000 174,000
Deferred income taxes........................ 8,803 -- -- -- 8,803
Shareholders' equity......................... 158,178 11,099 6,971 (154,300) 21,948
------------ --------- ---------- --------------- ------------
$ 207,914 $ 25,376 $ 24,388 $ (4,300) $ 253,378
------------ --------- ---------- --------------- ------------
------------ --------- ---------- --------------- ------------
</TABLE>
Pro forma adjustments to the balance sheet information reflect the reduction
in cash, increase in long-term debt and change in common stock outstanding as a
result of the Olson's merger and the recapitalization. Pro forma adjustments to
the statement of earnings information reflect the related reduction in interest
income, increase in interest expense and additional depreciation and
amortization of the excess of the price paid in connection with the Olson's
merger over the fair value of the net tangible assets acquired.
The pro forma results are not necessarily indicative of what actually would
have occurred if the Olson's merger and the recapitalization had been in effect
for the period presented, are not intended to be a projection of future results
and do not reflect any synergies that might be achieved from combined
operations. Nonrecurring charges of $1,400,000 directly resulting from the
recapitalization are not reflected in the pro forma information for the 53 weeks
ended December 31, 1994.
F-24
<PAGE>
QUALITY FOOD CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 30, 1995, DECEMBER 31, 1994 AND DECEMBER 25, 1993
(CONTINUED)
NOTE N
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Following is a presentation of selected financial data for each of the four
quarters of 1995 and 1994. (In thousands except earnings per share):
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
(12 WEEKS) (12 WEEKS) (12 WEEKS) (16 WEEKS)
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
1995
Sales........................................................... $ 138,938 $ 175,539 $ 176,057 $ 239,322
Cost of sales and related occupancy expenses.................... 104,656 131,659 132,861 181,257
Gross margin.................................................... 34,282 43,880 43,196 58,065
Operating income................................................ 7,712 11,071 10,099 13,896
Interest income................................................. 273 76 76 76
Interest expense................................................ 72 2,875 2,938 3,754
Other expense................................................... 1,400 -- -- --
Net earnings.................................................... 3,781 5,277 4,612 6,546
Earnings per share.............................................. .19 .36 .32 .45
Average shares outstanding...................................... 19,842 14,821 14,553 14,548
</TABLE>
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
(12 WEEKS) (12 WEEKS) (12 WEEKS) (17 WEEKS)
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
1994
Sales........................................................... $ 120,986 $ 127,182 $ 135,471 $ 192,239
Cost of sales and related occupancy expenses.................... 90,446 94,624 101,241 144,401
Gross margin.................................................... 30,540 32,558 34,230 47,838
Operating income................................................ 8,144 9,627 9,040 12,400
Interest income................................................. 162 189 221 361
Net earnings.................................................... 5,451 6,444 6,082 8,399
Earnings per share.............................................. .28 .33 .31 .43
Average shares outstanding...................................... 19,594 19,547 19,695 19,685
</TABLE>
F-25
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
HUGHES MARKETS, INC.
We have audited the accompanying consolidated balance sheets of HUGHES
MARKETS, INC. (a California corporation) AND SUBSIDIARIES as of February 26,
1995 and March 3, 1996, and the related consolidated statements of income,
shareholders' equity and cash flows for the three years in the period ended
March 3, 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Hughes Markets, Inc. and
Subsidiaries as of February 26, 1995 and March 3, 1996, and the results of their
operations and their cash flows for the three years in the period ended March 3,
1996, in conformity with generally accepted accounting principles.
/s/ARTHUR ANDERSEN LLP
LOS ANGELES, CALIFORNIA
MAY 10, 1996, EXCEPT FOR THE
MATTERS DISCLOSED IN NOTE 11 FOR
WHICH THE DATE IS NOVEMBER 20, 1996.
F-26
<PAGE>
HUGHES MARKETS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
FEBRUARY 26, MARCH 3, SEPTEMBER 29,
1995 1996 1996
------------ ----------- -------------
<S> <C> <C> <C>
(UNAUDITED)
CURRENT ASSETS:
Cash and cash equivalents................................................. $24,348,217 $31,999,667 $10,453,573
Accounts receivable, net of allowances of $427,270, $341,546 and $441,025
as of February 26, 1995, March 3, 1996, and September 29, 1996,
respectively............................................................ 19,647,217 20,788,846 18,175,078
Inventories, at cost...................................................... 52,775,428 50,095,352 53,966,366
Prepaid expenses and deposits............................................. 9,388,682 10,243,247 9,291,043
------------ ----------- -------------
Total current assets.................................................. 106,159,544 113,127,112 91,886,060
------------ ----------- -------------
PROPERTY AND EQUIPMENT, at cost:
Land...................................................................... 39,799,709 38,579,263 43,913,243
Buildings................................................................. 62,857,809 57,029,127 62,204,464
Market, automotive and office equipment................................... 141,421,645 151,713,977 158,977,138
Leasehold improvements.................................................... 43,532,936 46,669,490 48,384,807
Construction-in-process................................................... 11,871,502
------------ ----------- -------------
287,612,099 293,991,857 325,351,154
Less--Depreciation and amortization....................................... 106,131,836 121,915,875 131,477,731
------------ ----------- -------------
181,480,263 172,075,982 193,873,423
------------ ----------- -------------
PROPERTY UNDER CAPITAL LEASES, net of amortization.......................... 17,461,416 18,424,802 19,500,023
------------ ----------- -------------
OTHER ASSETS:
Lease acquisition costs, net of amortization of $4,693,553, $5,075,253 and
$5,255,749 as of February 26, 1995, March 3, 1996, and September 29,
1996, respectively...................................................... 5,332,729 4,951,029 4,945,397
Other..................................................................... 6,293,684 7,920,284 5,504,397
------------ ----------- -------------
11,626,413 12,871,313 10,449,794
------------ ----------- -------------
3$16,727,636 $316,499,209 $315,709,300
------------ ----------- -------------
------------ ----------- -------------
CURRENT LIABILITIES:
Accounts payable.......................................................... $52,934,500 $50,756,904 $53,678,299
Accrued liabilities....................................................... 36,325,725 38,019,396 38,673,998
Current portion of long-term debt......................................... 7,717,660 5,411,076 9,203,704
Current portion of obligations under capital leases....................... 554,094 549,759 558,572
Income taxes payable...................................................... 1,861,867 1,219,115
------------ ----------- -------------
Total current liabilities............................................. 97,531,979 96,599,002 103,333,688
------------ ----------- -------------
LONG-TERM DEBT, less current portion........................................ 34,266,184 22,051,704 3,043,650
------------ ----------- -------------
OBLIGATIONS UNDER CAPITAL LEASES, less current portion...................... 22,093,947 23,556,188 24,923,943
------------ ----------- -------------
DEFERRED INCOME TAXES....................................................... 9,363,459 8,845,146 8,644,496
------------ ----------- -------------
OTHER NON-CURRENT LIABILITIES............................................... 5,623,182 4,372,114 6,623,359
------------ ----------- -------------
MINORITY INTEREST........................................................... 9,874,274 9,531,344 8,369,068
------------ ----------- -------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Preferred stock, stated at redemption value:
Authorized--640,000,000 shares
Outstanding--20,967,000 shares.......................................... 209,670 209,670 209,670
Common stock, nominal par value:
Authorized--10,000,000 shares
Outstanding--5,689,230, 5,612,385 and 5,588,360 as of February 26, 1995,
March 3, 1996, and September 29, 1996, respectively................... 5,689 5,612 5,588
Additional paid-in capital................................................ 4,916,362 5,122,850 5,457,620
Retained earnings......................................................... 133,831,697 147,203,762 156,054,919
------------ ----------- -------------
138,963,418 152,541,894 161,727,797
Less--Notes receivable from shareholders.................................. (988,807) (998,183) (956,701)
------------ ----------- -------------
137,974,611 151,543,711 160,771,096
------------ ----------- -------------
3$16,727,636 $316,499,209 $315,709,300
------------ ----------- -------------
------------ ----------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-27
<PAGE>
HUGHES MARKETS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE YEARS ENDED FOR THE SEVEN MONTHS ENDED
------------------------------------------- ----------------------------
<S> <C> <C> <C> <C> <C>
FEBRUARY 27, FEBRUARY 26, MARCH 3, SEPTEMBER 24, SEPTEMBER 29,
1994 1995 1996 1995 1996
------------- ------------- ------------- ------------- -------------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
NET SALES................................. $1,083,708,509 $1,110,947,177 $1,147,447,465 $647,486,382 $675,431,524
COST OF SALES, INCLUDING DISTRIBUTION AND
OCCUPANCY EXPENSES...................... 854,624,006 884,862,010 901,951,393 509,071,748 529,909,430
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES................................ 206,289,167 209,211,036 215,234,435 122,631,371 126,492,863
------------- ------------- ------------- ------------- -------------
Income from operations................ 22,795,336 16,874,131 30,261,637 15,783,263 19,029,231
------------- ------------- ------------- ------------- -------------
OTHER INCOME (EXPENSE):
INTEREST INCOME........................... 796,288 1,054,317 1,271,754 1,203,903 708,628
INTEREST EXPENSE.......................... (4,598,498) (4,664,150) (4,335,433) (2,595,385) (2,100,190)
------------- ------------- ------------- ------------- -------------
(3,802,210) (3,609,833) (3,063,679) (1,391,482) (1,391,562)
Income before provision for income
taxes and minority interest......... 18,993,126 13,264,298 27,197,958 14,391,781 17,637,669
PROVISION FOR INCOME TAXES................ 7,974,000 5,631,000 11,382,473 6,129,956 8,401,246
------------- ------------- ------------- ------------- -------------
Income before minority interest....... 11,019,126 7,633,298 15,815,485 8,261,825 9,236,423
MINORITY INTEREST IN SUBSIDIARY LOSS...... 204,776 740,948 369,033 272,419 1,162,367
------------- ------------- ------------- ------------- -------------
NET INCOME................................ $ 11,223,902 $ 8,374,246 $ 16,184,518 $ 8,534,244 $10,398,790
------------- ------------- ------------- ------------- -------------
------------- ------------- ------------- ------------- -------------
NET INCOME PER COMMON SHARE............... $ 1.95 $ 1.47 $ 2.87 $ 1.51 $ 1.86
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING............................. 5,735,893 5,700,558 5,640,369 5,654,600 5,594,942
</TABLE>
The accompanying notes are an integral part of these consolidated Financial
Statements.
F-28
<PAGE>
HUGHES MARKETS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED FEBRUARY 27, 1994, FEBRUARY 26, 1995
AND MARCH 3, 1996 AND FOR THE SEVEN MONTHS ENDED
SEPTEMBER 24, 1995 AND SEPTEMBER 29, 1996
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK NOTES
------------------------ --------------------- ADDITIONAL RECEIVABLE
REDEMPTION PAR PAID-IN RETAINED FROM
SHARES VALUE SHARES VALUE CAPITAL EARNINGS SHAREHOLDERS
----------- ----------- ---------- --------- ----------- -------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, February 28, 1993.... 20,967,000 $ 209,670 5,757,028 $ 5,757 $ 4,506,891 $ 117,305,788 $ (950,955)
Repayments of notes
receivable from share-
holders................... 223,016
Purchases and cancellation
of stock.................. (31,387) (32) (733,622)
Proceeds from sale and
issuance of stock......... 4,800 5 116,827 (116,832)
Dividends................... (501,338)
Net income.................. 11,223,902
----------- ----------- ---------- --------- ----------- -------------- ------------
BALANCE, February 27, 1994.... 20,967,000 209,670 5,730,441 5,730 4,623,718 127,294,730 (844,771)
Repayments of notes
receivable from share-
holders................... 148,619
Purchases and cancellation
of stock.................. (52,411) (52) (1,337,671)
Proceeds from sale and
issuance of stock......... 11,200 11 292,644 (292,655)
Dividends................... (499,608)
Net income.................. 8,374,246
----------- ----------- ---------- --------- ----------- -------------- ------------
BALANCE, February 26, 1995.... 20,967,000 209,670 5,689,230 5,689 4,916,362 133,831,697 (988,807)
Repayments of notes
receivable from share-
holders................... 197,119
Purchases and cancellation
of stock.................. (84,045) (84) (2,317,551)
Proceeds from sale and
issuance of stock......... 7,200 7 206,488 (206,495)
Dividends................... (494,902)
Net income.................. 16,184,518
----------- ----------- ---------- --------- ----------- -------------- ------------
BALANCE, March 3,
1996........................ 20,967,000 209,670 5,612,385 5,612 5,122,850 147,203,762 (998,183)
Repayments of notes
receivable from share-
holders................... 41,482
Purchases and cancellation
of stock.................. (35,225) (35) (1,058,568)
Proceeds from sale and
issuance of stock......... 11,200 11 334,770
Dividends................... (489,065)
Net income.................. 10,398,790
----------- ----------- ---------- --------- ----------- -------------- ------------
BALANCE, September 29, 1996
(unaudited)................. 20,967,000 $ 209,670 5,588,360 $ 5,588 $ 5,457,620 $ 156,054,919 $ (956,701)
----------- ----------- ---------- --------- ----------- -------------- ------------
----------- ----------- ---------- --------- ----------- -------------- ------------
<CAPTION>
TOTAL
SHAREHOLDERS'
EQUITY
--------------
<S> <C>
BALANCE, February 28, 1993.... $ 121,077,151
Repayments of notes
receivable from share-
holders................... 223,016
Purchases and cancellation
of stock.................. (733,654)
Proceeds from sale and
issuance of stock.........
Dividends................... (501,338)
Net income.................. 11,223,902
--------------
BALANCE, February 27, 1994.... 131,289,077
Repayments of notes
receivable from share-
holders................... 148,619
Purchases and cancellation
of stock.................. (1,337,723)
Proceeds from sale and
issuance of stock.........
Dividends................... (499,608)
Net income.................. 8,374,246
--------------
BALANCE, February 26, 1995.... 137,974,611
Repayments of notes
receivable from share-
holders................... 197,119
Purchases and cancellation
of stock.................. (2,317,635)
Proceeds from sale and
issuance of stock.........
Dividends................... (494,902)
Net income.................. 16,184,518
--------------
BALANCE, March 3,
1996........................ 151,543,711
Repayments of notes
receivable from share-
holders................... 41,482
Purchases and cancellation
of stock.................. (1,058,603)
Proceeds from sale and
issuance of stock......... 334,781
Dividends................... (489,065)
Net income.................. 10,398,790
--------------
BALANCE, September 29, 1996
(unaudited)................. $ 160,771,096
--------------
--------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-29
<PAGE>
HUGHES MARKETS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED FOR THE SEVEN MONTHS ENDED
------------------------------------------ -----------------------------
<S> <C> <C> <C> <C> <C>
FEBRUARY 27, FEBRUARY 26, MARCH 3, SEPTEMBER 24, SEPTEMBER 29,
1994 1995 1996 1995 1996
------------- ------------ ------------- ------------- --------------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.............................................. $ 11,223,902 $ 8,374,246 $ 16,184,518 $ 8,534,244 $ 10,398,790
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization........................... 19,309,646 21,313,241 19,570,835 9,309,300 12,111,151
Loss on sale of property................................ 160,080 109,934 26,391
Minority interest....................................... (204,776) (740,948) (342,930) (272,419) (1,162,276)
Changes in assets and liabilities:
Accounts receivable..................................... (1,974,115) 421,547 (1,141,629) 783,816 2,613,768
Inventories............................................. (9,897,817) (2,989,590) 2,680,076 1,780,508 (3,871,014)
Prepaid expenses and deposits........................... (2,522,384) (2,353,790) (854,565) 271,970 952,204
Accounts payable........................................ 8,184,401 8,682,642 (2,177,596) 1,211,742 2,921,395
Accrued liabilities..................................... 4,036,596 1,917,488 1,693,671 5,372,296 654,602
Income taxes payable.................................... 3,283,419 (3,556,176) 1,861,867 924,978 (642,752)
Deferred income taxes................................... (1,634,000) 1,197,000 (518,313) (605,176) (200,650)
Other, net.............................................. (354,869) (286,725) (3,359,973) (2,449,678) 2,175,735
------------- ------------ ------------- ------------- --------------
Net cash provided by operating activities............... 29,610,083 32,088,869 33,622,352 24,861,581 25,950,953
------------- ------------ ------------- ------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment..................... (31,700,927) (36,062,608) (19,633,316) (3,847,798) (30,938,746)
Proceeds from sale of property and equipment............ 5,043,724 448,022 10,670,178 5,224,140 102,131
Proceeds from non-current deposits...................... 675,922 703,246
Payments on non-current deposits........................ (48,938) (112,489)
------------- ------------ ------------- ------------- --------------
Net cash provided by (used in) investing activities..... (26,657,203) (34,987,602) (8,372,381) 1,376,342 (30,836,615)
------------- ------------ ------------- ------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under long-term debt......................... 6,944,443 6,000,000 2,796,731 3,000,000
Repayments of long-term debt............................ (882,271) (17,317,795) (18,200,116) (18,215,426)
Repayments of notes receivable from shareholders........ 290,932 222,356 277,174 88,819 91,313
Principal payments on obligations under capital
leases................................................ (482,015) (547,267) (542,094) (322,823) (323,432)
Proceeds from sale of common stock...................... 334,781
Repurchases of common stock............................. (733,654) (1,337,723) (2,317,635) (1,466,803) (1,058,603)
Payment of dividends.................................... (501,338) (499,608) (494,902) (494,902) (489,065)
------------- ------------ ------------- ------------- --------------
Net cash provided by (used in) financing activities..... 5,518,368 2,955,487 (17,598,521) (20,395,825) (16,660,432)
------------- ------------ ------------- ------------- --------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.... 8,471,248 56,754 7,651,450 5,842,098 (21,546,094)
CASH AND CASH EQUIVALENTS, beginning of period.......... 15,820,215 24,291,463 24,348,217 24,348,217 31,999,667
------------- ------------ ------------- ------------- --------------
CASH AND CASH EQUIVALENTS, end of period................ $ 24,291,463 $ 24,348,217 $ 31,999,667 $30,190,315 $ 10,453,573
------------- ------------ ------------- ------------- --------------
------------- ------------ ------------- ------------- --------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION:
Cash paid for interest.................................. $ 4,600,483 $ 4,518,823 $ 4,442,464 $ 2,421,506 $ 2,076,007
Cash paid for income taxes.............................. $ 6,086,548 $ 8,105,874 $ 8,700,000 $ 4,926,000 $ 9,276,500
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES:
Issuance of common stock for notes receivable........... $ 116,832 $ 292,655 $ 206,495
Purchases of property under capital leases.............. $ 2,000,000 $ 2,000,000 $ 1,700,000
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-30
<PAGE>
HUGHES MARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
Hughes Markets, Inc. (the Company), its wholly owned subsidiary, Hughes Realty,
Inc. (HRI) and its 51 percent owned subsidiary, Santee Dairies, Inc. (Santee).
See Note 11 regarding ownership changes subsequent to March 3, 1996. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
B. DESCRIPTION OF BUSINESS
The Company operates a chain of supermarkets through which it sells food and
nonfood items in the Southern California area. HRI is a real estate entity which
holds two of the Company's stores. Santee is a dairy which produces fluid milk
and juice products. Santee sells its products to its owners as well as to
outside parties.
C. INVENTORY VALUATION
The Company values its inventory associated with its supermarket operations
at cost using the last-in, first-out (LIFO) method. If the inventory had been
valued using the first-in, first-out (FIFO) method, inventory balances would
have been $17,068,155, $16,844,154 and $17,719,154 (unaudited) greater at
February 26, 1995, March 3, 1996 and September 29, 1996, respectively.
Santee's inventory balances of $3,266,189, $4,393,411 and $4,290,244
(unaudited) at February 26, 1995, March 3, 1996 and September 29, 1996,
respectively, which consist primarily of raw materials and supplies, are valued
using the lower of FIFO cost or market.
D. INCOME TAXES
Income taxes are accounted for in accordance with Statement of Financial
Accounting Standards (SFAS) No. 109 "Accounting for Income Taxes." Under the
assets and liability method of SFAS No. 109, deferred tax assets and liabilities
are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases.
E. PROPERTY AND EQUIPMENT
Depreciation of buildings and equipment and amortization of leasehold
improvements are computed on a straight-line basis. Property under capital
leases is amortized using methods consistent with the Company's depreciation
policy for purchased assets, except that depreciation is computed over the lease
term or useful life, whichever is less.
Estimated useful lives for the principal asset classifications are as
follows:
<TABLE>
<S> <C>
10 to 50
Buildings.................................................... years
Equipment.................................................... 3 to 25 years
Leasehold improvements....................................... Lease term
</TABLE>
F-31
<PAGE>
HUGHES MARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Maintenance and repairs are charged to expense as incurred and major
replacements and improvements are capitalized. The cost and accumulated
depreciation of items sold or retired are removed from the property accounts,
and any resultant gain or loss is recognized currently.
F. LEASE ACQUISITION COSTS
Costs associated with the acquisition of certain leases are capitalized and
amortized on a straight-line basis over the terms of the related leases.
G. CASH FLOWS
The Company uses the indirect method as prescribed by SFAS No. 95 for
presentation of its cash flows. The Company considers all investment instruments
with original maturities of less than three months to be cash equivalents.
H. FISCAL YEAR
The Company's fiscal year ends on the Sunday closest to the last day of
February. Fiscal year 1996 was a 53 week year, fiscal 1995 and fiscal 1994
covered 52 weeks. The seven months ended September 24, 1995 and September 29,
1996 covered 30 weeks.
I. USE OF ESTIMATES
The preparation of financial statements in conformity 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 revenues and expenses during the
reporting period. Actual results could differ from these estimates.
J. EARNINGS PER SHARE
Earnings per share is based upon the weighted average number of common
shares and common stock equivalents outstanding during the periods. Net income
has been reduced for preferred dividends.
K. NEW FINANCIAL ACCOUNTING PRONOUNCEMENTS
In 1995, SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of," was issued. SFAS No. 121 is
effective for fiscal years beginning after December 15, 1995 and will have no
impact on the Company's results of operations.
In 1995, SFAS No. 123, "Accounting for Stock-Based Compensation," was
issued. SFAS No. 123 is effective for fiscal years beginning after December 15,
1995 and will have no impact on the Company's results from operations.
L. RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the fiscal
1996 presentation.
F-32
<PAGE>
HUGHES MARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. PREFERRED STOCK
The Company's preferred shares are voting, entitled to non-cumulative
dividends of $0.0006 per share per year and preference in liquidation of $0.01
per share. They are redeemable at the option of the Company upon the payment of
$0.01 per share plus any declared but unpaid dividends. For the years ended
February 27, 1994, February 26, 1995 and March 3, 1996, the board of directors
declared dividends in the amount of $0.0006 per preferred share and $.085 per
common share.
The Company's bylaws provide that the Company has the option to repurchase
stock at any time by giving notice to the holder, at a price equal to book value
or at the holder's cost of common stock, whichever is greater, and repurchase
the preferred stock at the redemption value of $0.01 per share plus any declared
but unpaid dividend.
3. STOCK OPTIONS
The Company has a stock option plan (the Plan) which provides for the
granting of options to officers and certain key employees for the purpose of
purchasing common shares. The exercise price of the options is equivalent to the
book value (as defined by the Plan) of the common stock or its par value,
whichever is greater, at the date such options were exercised.
Transactions under the Plan are summarized as follows:
<TABLE>
<CAPTION>
NUMBER EXERCISE PRICE
OF SHARES PER SHARES
----------- -----------------
<S> <C> <C>
Outstanding at February 28, 1993.................................................... -- --
Granted........................................................................... 4,800 $ 24.34
Exercised......................................................................... (4,800) $ 24.34
Canceled.......................................................................... -- --
----------- -----------------
Outstanding at February 27, 1994.................................................... -- --
Granted........................................................................... 11,200 $ 26.13
Exercised......................................................................... (11,200) $ 26.13
Canceled.......................................................................... -- --
----------- -----------------
Outstanding at February 26, 1995.................................................... -- --
Granted........................................................................... 7,200 $ 28.68
Exercised......................................................................... (7,200) $ 28.68
Canceled.......................................................................... -- --
----------- -----------------
Outstanding at March 3, 1996........................................................ -- --
Granted........................................................................... 11,200 $ 29.83--$30.40
Exercised......................................................................... (11,200) $ 29.83--$30.40
Canceled.......................................................................... -- --
----------- -----------------
Outstanding at September 29,
1996 (Unaudited).................................................................... -- --
----------- -----------------
----------- -----------------
</TABLE>
For the years ended February 27, 1994, February 26, 1995 and March 3, 1996,
the Company repurchased 31,387, 52,411 and 84,045 shares of common stock for
$733,654, $1,337,723 and $2,317,635, respectively, which represented the book
value (as defined in the Plan) of the common shares at the date of purchase.
F-33
<PAGE>
HUGHES MARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. STOCK OPTIONS (CONTINUED)
As of February 26, 1995, March 3, 1996 and September 29, 1996, the Company
had extended loans of $988,807, $998,183 and $956,701 (unaudited), respectively,
to certain officers and employees to purchase stock under the Plan. The loans,
which are collateralized by the common shares, bear interest of 4.81 to 9.25
percent, and have varying repayment terms, not exceeding ten years.
4. LONG-TERM DEBT
The Company has a $32,000,000 revolving loan facility. Provisions under the
facility require the Company to comply with certain financial covenants
including the maintenance of a minimum tangible net worth, a funded indebtedness
to capital ratio, an interest coverage ratio and a limitation on the debt to
tangible net worth ratio. As of September 29, 1996, no amounts were outstanding
under the $32,000,000 revolving loan facility.
Santee has a revolving line of credit providing for borrowings of up to
$5,000,000. The unused portion of the revolving line of credit is subject to an
annual commitment fee of 1/4 of 1 percent.
F-34
<PAGE>
HUGHES MARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. LONG-TERM DEBT (CONTINUED)
Long-term debt outstanding consists of the following:
<TABLE>
<CAPTION>
FEBRUARY 26, MARCH 3, SEPTEMBER 29,
1995 1996 1996
------------- ------------- -------------
<S> <C> <C> <C>
(UNAUDITED)
Revolving loan, unsecured, interest at the prime rate or LIBOR plus
5/8 percent at the time of borrowing (8.38% at March 3, 1996).
Principal may be repaid and reborrowed until maturity, October 31,
2000.............................................................. $ -- $ 17,000,000 $ --
Revolving loan, unsecured, interest at LIBOR plus 5/8 percent at the
time of borrowing (6.69% at February 26, 1995). Principal due
quarterly at an increasing rate during the period September 30,
1995 through June 30, 1998........................................ 24,000,000 -- --
Revolving loan, unsecured, interest at 9.13% at February 26, 1995.
Principal due quarterly at an increasing rate during the period
September 30, 1995 through June 30, 1998.......................... 8,000,000 -- --
Non-negotiable certificates of indebtedness, interest payable
quarterly at 7 and 8 percent, due at various dates through
1998.............................................................. 6,274,544 6,455,851 5,897,578
Note payable, secured by store equipment and fixtures, interest at
9.4 percent, due in monthly installments of $103,986 including
interest through August 1996...................................... 1,751,538 615,992 306,901
Note payable, secured by land and building, interest at 6 percent,
due in monthly installments of $42,977 including interest through
December 1997..................................................... 1,341,323 893,874 620,222
Notes payable, collateralized by deeds of trust and equipment,
interest at 8.25 to 8.75 percent, due through January 2001........ 616,439 497,063 422,653
Revolving line of credit with a bank, interest at bank's reference
rate plus one-half percent, interest due monthly, principal due
December 1, 1996.................................................. -- 2,000,000 5,000,000
------------- ------------- -------------
41,983,844 27,462,780 12,247,354
Less--Current portion............................................... 7,717,660 5,411,076 9,203,704
------------- ------------- -------------
$ 34,266,184 $ 22,051,704 $ 3,043,650
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
F-35
<PAGE>
HUGHES MARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. LONG-TERM DEBT (CONTINUED)
As of March 3, 1996, long-term debt matures as follows:
<TABLE>
<CAPTION>
FISCAL YEAR:
<S> <C>
1997........................................................................... $ 5,411,076
1998........................................................................... 2,400,940
1999........................................................................... 2,525,930
2000........................................................................... 61,278
2001........................................................................... 17,055,067
Thereafter..................................................................... 8,489
-------------
$ 27,462,780
-------------
-------------
</TABLE>
5. INCOME TAXES
The significant components of the consolidated provision for income tax for
the fiscal years ended February 27, 1994, February 26, 1995 and March 3, 1996,
are as follows:
<TABLE>
<CAPTION>
1994 1995 1996
------------- ------------ -------------
<S> <C> <C> <C>
Current........................................... $ 9,608,000 $ 4,434,000 $ 10,864,000
Deferred.......................................... (1,634,000) 1,197,000 518,000
------------- ------------ -------------
$ 7,974,000 $ 5,631,000 $ 11,382,000
------------- ------------ -------------
------------- ------------ -------------
</TABLE>
The tax effect of temporary differences and carryforwards which give rise to
deferred tax assets and liabilities at February 26, 1995 and March 3, 1996 are
as follows:
<TABLE>
<CAPTION>
1995 1996
-------------- --------------
<S> <C> <C>
Deferred tax assets:
Workers compensation accrual................................ $ 2,306,577 $ 1,687,251
Capitalize leases........................................... 1,696,904 1,773,723
California state taxes...................................... 673,254 1,173,605
Self insurance reserve...................................... 1,338,942 1,338,942
Vacation accrual............................................ 952,501 987,039
Other....................................................... 1,956,964 3,331,887
-------------- --------------
8,925,142 10,292,447
-------------- --------------
Deferred tax liabilities:
Plant and equipment basis differences....................... (10,702,118) (11,666,038)
Union pension benefits paid................................. (3,324,338) (3,978,062)
Other....................................................... (4,262,145) (3,493,493)
-------------- --------------
(18,288,601) (19,137,593)
-------------- --------------
Net deferred tax liability.................................... $ 9,363,459 $ 8,845,146
-------------- --------------
-------------- --------------
</TABLE>
F-36
<PAGE>
HUGHES MARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INCOME TAXES (CONTINUED)
The differences between the Company's effective income tax rates and the
federal statutory rates are summarized as follows:
<TABLE>
<CAPTION>
1994 1995 1996
--------- --------- ---------
<S> <C> <C> <C>
Statutory rate.......................................................... 35.0% 35.0% 35.0%
State taxes............................................................. 9.3 9.3 9.3
Other................................................................... (2.3) (1.8) (2.4)
--- --- ---
Effective rate.......................................................... 42.0% 42.5% 41.9%
--- --- ---
--- --- ---
</TABLE>
6. LEASES
The Company leases a majority of its store facilities under long-term
leases. These leases extend for varying periods through 2023, and the majority
of the leases contain renewal options at rentals similar to those required
during the initial lease periods. In addition to required minimum lease
payments, taxes and insurance, contingent rentals may become payable under
certain leases on the basis of a percentage of sales in excess of stipulated
amounts.
The Company has capitalized certain leases in accordance with the
requirements of SFAS No. 13. The following is an analysis of property under
capital leases:
<TABLE>
<CAPTION>
FEBRUARY 26, MARCH 3,
1995 1996
-------------- -------------- SEPTEMBER 29,
1996
--------------
(UNAUDITED)
<S> <C> <C> <C>
Store facilities under capital leases............................ $ 26,000,306 $ 28,000,306 $ 29,700,306
Equipment under capital leases................................... 1,983,877 1,983,877 1,983,877
-------------- -------------- --------------
27,984,183 29,984,183 31,684,183
Less--Accumulated amortization................................... (10,522,767) (11,559,381) (12,184,160)
-------------- -------------- --------------
$ 17,461,416 $ 18,424,802 $ 19,500,023
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
F-37
<PAGE>
HUGHES MARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. LEASES (CONTINUED)
At March 3, 1996, future minimum obligations on capital and operating leases
were as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
-------------- --------------
<S> <C> <C>
Due in fiscal year:
1997....................................................... $ 3,278,551 $ 10,481,065
1998....................................................... 3,278,551 9,919,108
1999....................................................... 3,278,551 9,509,672
2000....................................................... 3,278,551 9,231,955
2001....................................................... 3,278,551 8,775,313
Thereafter................................................... 46,905,328 106,094,809
-------------- --------------
Minimum lease payments....................................... 63,298,083 $ 154,011,922
--------------
--------------
Less--Amount representing interest........................... (39,192,136)
--------------
Present value of minimum lease payments...................... 24,105,947
Current portion.............................................. (549,759)
--------------
Long-term portion............................................ $ 23,556,188
--------------
--------------
</TABLE>
Minimum lease obligations under capital leases include $22,060,197 payable
to partnerships, including principal shareholders of the Company.
As of March 3, 1996, the total minimum rent obligations under operating
leases include $9,016,978 due to partnerships, including principal shareholders
of the Company, and have not been reduced for minimum sublease rentals of
$203,715 due in the future under non-cancelable sublease agreements.
Rental expense related to non-cancelable operating leases is as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED FOR THE SEVEN MONTHS ENDED
------------------------------------------- ----------------------------
FEBRUARY 27, FEBRUARY 26, MARCH 3, SEPTEMBER 24, SEPTEMBER 29,
1994 1995 1996 1995 1996
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
(UNAUDITED)
Minimum rentals...................... $ 9,897,902 $ 10,635,245 $ 12,498,876 $ 8,634,473 $ 9,824,944
Contingent rentals................... 3,059,345 2,963,852 3,004,046 1,665,037 1,554,938
------------- ------------- ------------- ------------- -------------
12,957,247 13,599,097 15,502,922 10,299,510 11,379,882
Less--Sublease rentals............... (437,372) (395,777) (454,830) (250,478) (271,305)
------------- ------------- ------------- ------------- -------------
Net rental expense................... $ 12,519,875 $ 13,203,320 $ 15,048,092 $ 10,049,032 $ 11,108,577
------------- ------------- ------------- ------------- -------------
------------- ------------- ------------- ------------- -------------
</TABLE>
7. COMMITMENTS AND CONTINGENCIES
At March 3, 1996, the Company had approximately $8,982,626 in outstanding
letters of credit related to its workers' compensation insurance requirement
(see Note 10).
Various claims and lawsuits arising in the normal course of business are
pending against the Company. In the opinion of management, the ultimate outcome
of such actions will not materially affect the Company's financial position or
results of operations.
F-38
<PAGE>
HUGHES MARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. EMPLOYEE BENEFIT PLANS
Substantially all of the Company's hourly employees are covered by
union-sponsored, collectively bargained, multi-employer pension plans. The
Company contributed and charged to expense approximately $26,921,000,
$27,544,000 and $26,488,000 for the years ended February 27, 1994, February 26,
1995 and March 3, 1996, respectively. These contributions are determined in
accordance with the provisions of negotiated labor contracts and generally are
based on the number of hours worked. Information from the plans' administrators
is not available to permit the Company to determine its share of unfunded vested
benefits, if any.
For the years ended February 27, 1994, February 26, 1995 and March 3, 1996,
the Company recorded reductions (credits) of approximately $1,200,000,
$3,000,000 and $7,200,000, respectively, as an offset to required contributions
to the Southern California UFCW Unions and Food Employers Benefit Fund. For the
seven months ended September 29, 1996 and September 24, 1995 such credits were
approximately $3,000,000 and $2,400,000, respectively.
The Company also maintains a profit-sharing plan for its salaried employees;
Company contributions to the plan are determined by the board of directors.
Annual contributions were approximately $1,764,000, $1,570,000 and $2,563,000
for the years ended February 27, 1994, February 26, 1995 and March 3, 1996,
respectively.
The Company has deferred compensation arrangements with certain executives.
In connection with these compensation arrangements, the Company has purchased
life insurance policies on the lives of upper management and other non-union
employees in order to accumulate liquid assets with which the Company expects to
pay a substantial portion of the deferred compensation obligations as they
mature. The portion of deferred compensation obligations not paid from insurance
policy proceeds will be paid from the general assets of the Company. On the date
of their expected retirement or the date that deferred compensation payments
become vested the present value of the future deferred compensation payments due
participants will have been accrued.
9. DISCLOSURE ABOUT FAIR VALUE OF INVESTMENTS
The carrying value of the Company's long-term debt approximates fair value
based on quoted market prices for the same or similar issues or on the current
rates offered to the Company for debt of the same remaining maturities.
The Company maintains a non-current deposit with Certified Grocers of
California, Ltd. (Cergro), in the form of 7.1% of issued and outstanding Class B
Shares of Cergro as of February 6, 1996 (the record date for Cergro's 1996
Annual Meeting of Shareholders). Cergro is not obligated in any fiscal year to
redeem more than a prescribed number of the Class B Shares issued. In December
1995 Certified redeemed 4,240 shares of the Company's Class B shares for total
proceeds of approximately $703,000 and a total gain of approximately $200,000.
Cergro's fiscal 1996 Class B Shares redemption limit is 19,238 shares with
84,448 tendered for redemption as of Cergro's fiscal year ended September 2,
1995. Therefore, it is not practicable to estimate the fair value of this
investment. The investment is carried at its original cost of $3,631,334 in the
accompanying consolidated balance sheets. At September 2, 1995, the total assets
reported by Cergro were $398,603,000 ($398,569,000 in 1994), stockholders'
equity was $72,160,000 ($71,306,000 in 1994), annual revenues were
$1,822,804,000 ($1,873,872,000 in 1994), and net income was $769,000 ($94,000 in
1994).
F-39
<PAGE>
HUGHES MARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. WORKERS' COMPENSATION
The Company is partially self-insured as to workers' compensation claims and
provides for losses of estimated known and incurred but not reported insurance
claims. Known claims are estimated and accrued when reported, and the unpaid
long-term balance is classified as an other non-current liability in the
accompanying consolidated balance sheets. Incurred but not reported claims are
estimated and accrued based on the Company's experience and related actuarial
assumptions, and any long-term portion is also included in other non-current
liabilities in the accompanying consolidated balance sheets. At March 3, 1996
and February 26, 1995, the Company had accrued approximately $4,757,000 and
$5,240,000, respectively, for workers' compensation claims.
11. SUBSEQUENT EVENTS
On November 20, 1996, the Company signed a definitive agreement, whereby it
would merge with Quality Food Centers, Inc. in return for approximately $360
million in cash. The merger is expected to close in early 1997.
Santee has signed agreements with contractors to build a new dairy estimated
to cost approximately $100,000,000, including production equipment and
capitalized interest and other costs. Construction began during May 1996. As of
March 3, 1996 and September 29, 1996, Santee was out of compliance with certain
of its financial covenants. Santee has obtained waivers of non-compliance
through May 1996. On October 17, 1996, the bank extended the line of credit
through December 1, 1996. Presently, Santee is negotiating with the bank to
extend the line of credit and to obtain the appropriate waivers. In connection
with the new dairy, Santee extended the lease on the existing dairy until April
30, 1998.
In November 1996, the Company sold approximately 1 percent of its investment
in Santee to Stater Bros. Markets (Stater)(a 50 percent shareholder of Santee
after this investment). Also in November 1996, Santee sold approximately
$9,600,000 of additional preferred stock to the Company and Stater to provide
funds for the construction of the new dairy.
12. INFORMATION RELATED TO UNAUDITED INTERIM FINANCIAL STATEMENTS
A. BASIS OF PRESENTATION
The unaudited interim consolidated financial statements have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission.
Certain information and note disclosures normally included in annual financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to those rules and regulations, although
the Company believes that the disclosures made are adequate to make the
information presented not misleading. These unaudited consolidated financial
statements reflect, in the opinion of management, all adjustments (which include
only normal recurring adjustments) necessary to fairly present the results of
operations, changes in cash flows and financial position as of and for the
periods presented. The results for the interim periods presented are not
necessarily indicative of results to be expected for a full year.
B. PROVISION FOR INCOME TAXES
The provision for income taxes for the seven months ended September 24, 1995
and September 29, 1996 are based upon the estimated annualized rate for each of
the respective years.
F-40
<PAGE>
PROSPECTUS
$500,000,000
QUALITY FOOD CENTERS, INC.
DEBT SECURITIES
PREFERRED STOCK
COMMON STOCK
---------------------
Quality Food Centers, Inc. ("QFC" or the "Company") may issue and sell from
time to time (i) unsecured debt securities in one or more series, which may be
either senior (the "Senior Debt Securities"), senior subordinated (the "Senior
Subordinated Debt Securities") or subordinated (the "Subordinated Debt
Securities"; the Senior Debt Securities, the Senior Subordinated Debt Securities
and the Subordinated Debt Securities being referred to collectively as the "Debt
Securities"), (ii) shares of preferred stock, $.001 par value per share, in one
or more series (the "Preferred Stock") and (iii) shares of common stock, $.001
par value per share (the "Common Stock") . The Debt Securities, Preferred Stock
and Common Stock (collectively, the "Securities") will be limited to
$500,000,000 aggregate public offering price.
The specific terms of the particular Securities to be issued will be set
forth in a supplement to this Prospectus (a "Prospectus Supplement") which will
be delivered together with this Prospectus, including, where applicable, (i) in
the case of Common Stock, the number of shares, (ii) in the case of Preferred
Stock, the specific designation, number of shares and liquidation value thereof
and the dividend, liquidation, redemption, voting and other rights, including
conversion or exchange rights, if any, and any other special terms and (iii) in
the case of Debt Securities, the specific designation, aggregate principal
amount, authorized denominations, maturity, interest rate (or manner of
calculation thereof) and time of payment of interest, if any, and redemption or
repayment terms, if any, the currency, currencies or currency unit or units in
which the Debt Securities shall be payable, whether such Debt Securities will be
subordinated, any other rights, including conversion or exchange rights, if any,
and any other special terms or covenants. The Prospectus Supplement will also
contain information regarding the initial public offering price, the net
proceeds to QFC and, where applicable, the United States Federal income tax
considerations relating to the Securities covered by the Prospectus Supplement.
QFC may sell Securities to or through one or more underwriters, and may also
sell Securities directly to other purchasers or through dealers or agents. See
"Plan of Distribution." The accompanying Prospectus Supplement sets forth the
names of any underwriters, dealers or agents involved in the sale of the
Securities in respect of which this Prospectus is being delivered, and any
applicable fee, commission or discount arrangements with them.
QFC's Common Stock is listed on the Nasdaq National Market under the symbol
"QFCI." The Prospectus Supplement will contain information about any listing on
a securities exchange or other trading market of the Securities covered by the
Prospectus Supplement.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
------------------------
THIS PROSPECTUS MAY NOT BE USED TO CONSUMMATE SALES OF SECURITIES
UNLESS ACCOMPANIED BY A PROSPECTUS SUPPLEMENT.
The date of this Prospectus is January 27, 1997
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS OR
IN THE PROSPECTUS SUPPLEMENT IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS OR THE PROSPECTUS SUPPLEMENT AND, IF GIVEN OR MADE, SUCH INFORMATION
OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY QFC OR
BY ANY UNDERWRITER, DEALER OR AGENT. THIS PROSPECTUS AND THE PROSPECTUS
SUPPLEMENT DO NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO
BUY ANY OF THE SECURITIES OFFERED HEREBY OR THEREBY IN ANY JURISDICTION TO ANY
PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION IN SUCH
JURISDICTION. THIS PROSPECTUS AND THE PROSPECTUS SUPPLEMENT DO NOT CONSTITUTE AN
OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN
THOSE TO WHICH THEY RELATE. THE DELIVERY OF THIS PROSPECTUS OR THE PROSPECTUS
SUPPLEMENT AT ANY TIME DOES NOT IMPLY THAT THE INFORMATION HEREIN OR THEREIN IS
CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
------------------------
AVAILABLE INFORMATION
QFC is subject to the informational requirements of the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), and in accordance therewith files
reports, proxy and information statements and other information with the
Securities and Exchange Commission (the "SEC"). Such reports, proxy and
information statements and other information filed by QFC can be inspected and
copied at the public reference facilities of the SEC, Room 1024, Judiciary
Plaza, 450 Fifth Street, N.W., Washington, DC 20549, as well as at the following
SEC Regional Offices: Seven World Trade Center, New York, NY 10048; and
Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, IL
60661-2511. Copies can be obtained from the SEC by mail at prescribed rates.
Requests should be directed to the SEC's Public Reference Section, Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, DC 20549. The Commission
maintains a Web site that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the
Commission. The address of such site is http://www.sec.gov.
QFC has filed with the SEC a Registration Statement on Form S-3 (together
with all amendments and exhibits thereto, the "Registration Statement") under
the Securities Act of 1933, as amended (the "Securities Act"), covering the
Securities offered hereby. This Prospectus does not contain all of the
information set forth in the Registration Statement, certain parts of which are
omitted from the Prospectus in accordance with the rules and regulations of the
SEC. For further information, reference is made to the Registration Statement.
------------------------
INCORPORATION OF DOCUMENTS BY REFERENCE
The following documents are incorporated herein by reference:
(1) QFC's Annual Report on Form 10-K for the year ended December 30, 1995;
(2) QFC's Quarterly Reports on Form 10-Q for the twelve weeks ended March
23, 1996, the twelve weeks ended June 15, 1996 and the twelve weeks ended
September 7, 1996; and
(3) QFC's Current Report on Form 8-K dated November 12, 1996, as amended by
QFC's Current Reports on Form 8-K/A dated December 24, 1996 and December
27, 1996.
All documents filed pursuant to Section 13(a), 13(c), 14 or 15(d) of the
Exchange Act subsequent to the date of this Prospectus and prior to the
termination of the offering shall be deemed to be incorporated by reference in
this Prospectus and to be a part hereof from the date of filing of such
documents. Any statement contained in a document incorporated or deemed to be
incorporated by reference herein shall be deemed to be modified or superseded
for purposes of this Prospectus to the extent that a statement contained herein
or in any other subsequently filed document which also is or is deemed to be
incorporated by reference herein modifies or supersedes such statement. Any such
statement so modified or superseded shall not be deemed, except as so modified
or superseded, to constitute a part of this Prospectus.
Copies of the above documents (excluding exhibits to such documents, unless
such exhibits are specifically incorporated by reference therein) may be
obtained upon written or oral request without charge by each person to whom this
Prospectus is delivered from the Treasurer of QFC, 10112 N.E. 10th Street,
Bellevue, Washington 98004 (telephone number (206) 455-3761).
2
<PAGE>
THE COMPANY
QFC operates a chain of supermarkets in the Seattle/Puget Sound region in
the State of Washington. QFC began operations in 1954 with four stores and has
grown through acquisition and new store development to 64 stores today. QFC is
incorporated under the laws of the State of Washington and has its principal
executive offices at 10112 N.E. 10th Street, Bellevue, Washington 98004
(telephone number (206) 455-3761).
THE ACQUISITIONS
The statements made under this heading relating to the proposed acquisitions
of Hughes Markets, Inc. and Keith Uddenberg, Inc. (collectively, the
"Acquisitions") are summaries of the agreements described herein, do not purport
to be complete and are qualified in their entirety by reference to such
agreements, which have been filed as exhibits to the Registration Statement of
which this Prospectus is a part.
HUGHES MARKETS, INC.
HUGHES MERGER AGREEMENT. QFC, QHI Acquisition Corporation ("QHI"), a
California corporation and as of the date hereof, a wholly owned subsidiary of
QFC, and Hughes Markets, Inc. ("Hughes"), a California corporation, entered into
an Agreement and Plan of Merger, dated as of November 20, 1996 (the "Hughes
Merger Agreement"), pursuant to which QHI will be merged with and into Hughes
(the "Hughes Acquisition"), with Hughes continuing as the surviving corporation.
The aggregate consideration to be paid for all outstanding shares of common
stock of Hughes will be approximately $360 million (the "Hughes Purchase Price")
and will be subject to increase for each week that the Hughes Acquisition is
delayed past a certain deadline because of a delay in obtaining the financing
for the Hughes Acquisition, subject to certain exceptions. In lieu of calling
and convening a meeting of its shareholders, Hughes has obtained the written
consent of the requisite majority of its shareholders for approval of the Hughes
Merger Agreement and the transactions contemplated thereby. Hughes is an
independently owned supermarket chain of 56 stores in southern California.
The respective obligations of QFC and Hughes to effect the Hughes
Acquisition are subject to the satisfaction of certain conditions, including but
not limited to (i) the termination or expiration of the relevant waiting period
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the
"HSR Act") and (ii) the absence of any judicial order or legal restraint
preventing the consummation of the Hughes Acquisition. The obligations of QFC to
effect the Hughes Acquisition are further conditioned on, among others: (i) the
execution and delivery in a form reasonably satisfactory to QFC of all material
agreements, and all revisions, amendments and modifications thereto, relating to
the construction by Santee Dairy, Inc. ("Santee"), currently a 50% owned
affiliate of Hughes, of a new dairy plant (such agreements, as revised, amended
or otherwise modified, the "Santee Agreements"); (ii) the total capital cost of
constructing Santee's new plant not exceeding specified limits; and (iii) there
not having occurred and be continuing for at least ten consecutive trading days
(x) a decline of 20% or more in the Dow Jones Average of Industrial Stocks from
the November 20, 1996 closing level, (y) an increase of the yield on the ten
year U.S. Treasury notes to 8.50% per annum or higher or (z) a similar material
disruption in the capital markets which makes it impracticable for QFC to obtain
the necessary financing for the Hughes Acquisition. Except to the extent set
forth above in clause (iii), QFC's obligations to consummate the Hughes
Acquisition pursuant to the Hughes Merger Agreement are not conditioned upon its
ability to raise sufficient funds to do so.
The Hughes Merger Agreement contains customary representations, warranties
and covenants and provides for termination prior to closing under certain
circumstances. If the Hughes Merger Agreement is terminated (i) by mutual
consent of the parties, (ii) by either QFC or Hughes because the shareholders of
Hughes have not approved the Hughes Acquisition, or (iii) by QFC because (x) the
Board of Directors of
3
<PAGE>
Hughes withdraws its recommendation of the Hughes Acquisition or recommends the
acquisition of control of Hughes by a party other than QFC or any of its
subsidiaries (such party, a "Third Party" and such acquisition, a "Third Party
Acquisition"), (y) a Third Party acquires more than 25% of the common stock of
Hughes or (z) any of the Principal Shareholders (as defined below) breaches any
representation, warranty or covenant in the Principal Shareholders Agreement (as
defined below), and within 12 months Hughes effects a Third Party Acquisition,
then Hughes will pay to QFC a fee in the amount of $7.2 million.
PRINCIPAL SHAREHOLDERS AGREEMENT. Pursuant to the agreement, dated as of
November 20, 1996, by and among QFC and certain shareholders of Hughes who hold
approximately 91% of the common stock of Hughes (such shareholders, the
"Principal Shareholders"; such agreement, the "Principal Shareholders
Agreement"), the Principal Shareholders have agreed, among other things, (i) to
give their written consent to the Hughes Acquisition, to the execution and
delivery by Hughes of the Hughes Merger Agreement and the approval of the terms
thereof and to each of the other actions contemplated thereby and by the
Principal Shareholders Agreement; (ii) to vote all of their shares in favor of
the Hughes Merger Agreement and the transactions contemplated thereby at any
meeting of shareholders; and (iii) not to enter into any agreement to vote or to
give their written consent or any instructions inconsistent with clauses (i) or
(ii). The written consents of all Principal Shareholders approving the Hughes
Merger Agreement and the transactions contemplated thereby were delivered to QFC
by November 25, 1996.
SANTEE DAIRIES. Hughes and Stater Bros. Inc. ("Stater Bros.") are co-owners
of Santee, which operates one of the largest dairy plants in California. Prior
to November 1996, Santee was a 51%-owned subsidiary of Hughes, and the accounts
of Santee were included in the consolidated financial statements of Hughes. In
November 1996, Hughes sold a 1% interest in Santee to Stater Bros. (which
previously owned 49% of Santee), resulting in (i) Hughes and Stater Bros. each
becoming 50% owners of Santee and (ii) Santee ceasing to be a consolidated
subsidiary of Hughes.
KEITH UDDENBERG, INC.
KUI MERGER AGREEMENT. QFC, KU Acquisition Corporation ("KUA"), a Washington
corporation and wholly-owned subsidiary of QFC, and Keith Uddenberg, Inc.
("KUI"), a Washington corporation, entered into an Agreement and Plan of Merger,
dated as of December 18, 1996 (the "KUI Merger Agreement"), pursuant to which
KUI will be merged with and into KUA (the "KUI Acquisition"), with KUA
continuing as the surviving corporation. The aggregate consideration to be paid
for all outstanding shares of capital stock of KUI will be approximately $76.1
million, less any debt of KUI outstanding at the time of the KUI Acquisition,
plus working capital of KUI at the time of the KUI Acquisition, plus the
appraised fair market value of certain properties of KUI (which is estimated to
have a value of approximately $11.4 million), subject to certain further
adjustments. The consideration will be paid 50% in cash and 50% in Common Stock,
based on a fixed price per share of Common Stock of $39.075, although the
shareholders of KUI will have the option of being paid entirely in cash. Prior
to the KUI Acquisition, KUI will distribute to its shareholders, in a "spin-off"
transaction (the "Spin-Off"), certain property, including assets unrelated to
its grocery store business, real estate owned by KUI and one grocery store. KUI
operates 25 stores in the western and southern Puget Sound region of the State
of Washington.
The respective obligations of QFC and KUI to effect the KUI Acquisition are
subject to the satisfaction of certain conditions, including but not limited to
(i) the termination or expiration of the relevant waiting period under the HSR
Act, (ii) the absence of any judicial order or legal restraint preventing the
consummation of the KUI Acquisition and (iii) the qualification of the KUI
Acquisition as a tax-free reorganization under the Internal Revenue Code of
1986, as amended (unless the shareholders of KUI elect to receive all cash
consideration). The KUI Merger Agreement includes provisions pursuant to which
the parties may make certain adjustments to cause the KUI Acquisition to qualify
as a tax-free reorganization, if possible. The obligations of QFC to effect the
KUI Acquisition are further conditioned on, among other things, receipt of an
opinion of counsel to QFC as to certain tax matters, including the
4
<PAGE>
qualification of the Spin-Off as a tax-free transaction. QFC's obligation to
consummate the KUI Acquisition pursuant to the KUI Merger Agreement is not
conditioned upon its ability to raise sufficient funds to do so.
The KUI Merger Agreement contains customary representations, warranties and
covenants, including covenants of QFC intended to ensure the qualification of
the KUI Acquisition as a tax-free reorganization that may restrict the
disposition of the surviving corporation or its assets after the KUI
Acquisition. The KUI Merger Agreement also provides for termination prior to
closing under certain circumstances.
In addition, at the time of the KUI Acquisition QFC expects to enter into an
Investors Rights Agreement granting to the former KUI shareholders certain
demand and piggyback registration rights.
FINANCING
QFC expects that the cash consideration payable in the Acquisitions will be
financed by any of the following: (i) borrowings under QFC's credit facility, as
it may be amended, (ii) proceeds of debt and/or equity securities, or (iii) any
combination of the foregoing.
RATIOS OF EARNINGS TO FIXED CHARGES
The following table sets forth the ratios of earnings to fixed charges of
QFC for the periods indicated:
<TABLE>
<CAPTION>
FISCAL YEAR 36 WEEKS ENDED
- ----------------------------------------------------- SEPTEMBER 7, 1996
1991 1992 1993 1994 1995 -------------------
- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
22.43 22.70 17.64 15.71 3.30 3.28
</TABLE>
For purposes of these ratios, (i) earnings have been calculated by adding
interest expense and the estimated interest portion of rentals to earnings
before income taxes and (ii) fixed charges are comprised of interest expense and
the estimated interest portion of rentals.
USE OF PROCEEDS
The Securities may be offered by the Company from time to time as determined
by the Company. Unless otherwise indicated in the applicable Prospectus
Supplement, the net proceeds from the sale of the Securities will be added to
the Company's funds and will be used for general corporate purposes, including
development, acquisition or capital improvement of its stores and operations. If
the Acquisitions are consummated, the Company may use all or a portion of the
net proceeds from one or more series of the Securities to pay all or a portion
of the cash consideration payable in the Acquisitions. The Company may also use
borrowings under its credit facility, as it may be amended, to pay all or a
portion of such cash consideration and/or may use the proceeds from the sale of
other debt securities to pay all or a portion of such consideration.
DESCRIPTION OF DEBT SECURITIES
The Company may issue Debt Securities either separately, or together with,
or upon the conversion of or in exchange for, other Securities. The Debt
Securities are to be (i) senior unsecured obligations (the "Senior Debt
Securities") of the Company issued in one or more series under an Indenture (the
"Senior Indenture") to be entered into between the Company and the trustee to be
named therein (the "Senior Trustee"), (ii) senior subordinated unsecured
obligations (the "Senior Subordinated Debt Securities") of the Company issued in
one or more series under an Indenture (the Senior Subordinated Indenture") to be
entered into between the Company and the trustee to be named therein, or (iii)
subordinated unsecured obligations (the "Subordinated Debt Securities") of the
Company issued in one or more series under an Indenture (the "Subordinated
Indenture") to be entered into between the Company and the trustee to be named
therein (the "Subordinated Trustee"). The Senior Indenture, the Senior
Subordinated Indenture
5
<PAGE>
and the Subordinated Indenture are sometimes hereinafter referred to,
collectively, as the "Indentures" and, individually, as an "Indenture"; and the
Senior Trustee, Senior Subordinated Trustee and Subordinated Trustee are
sometimes hereinafter referred to, collectively, as the "Trustees" or
individually, as a "Trustee." The forms of the Indentures have been filed as
exhibits to the Registration Statement of which this Prospectus is a part. The
summary of certain provisions of the Indentures and the Debt Securities set
forth below and the summary of certain terms of a particular series of Debt
Securities set forth in the applicable Prospectus Supplement do not purport to
be complete and are subject to and are qualified in their entirety by reference
to all of the provisions of the Indentures, which provisions (including defined
terms) are incorporated herein by reference. Certain capitalized terms used
herein and not defined are defined in the Indentures. As used in this
"Description of Debt Securities," all references to the "Company" shall mean
Quality Food Centers, Inc., excluding, unless the context shall otherwise
require, its subsidiaries.
The following description of Debt Securities sets forth certain general
terms and provisions of the series of Debt Securities to which any Prospectus
Supplement may relate. Certain other specific terms of any particular series of
Debt Securities will be described in the applicable Prospectus Supplement. If so
indicated in the applicable Prospectus Supplement, the terms of the Debt
Securities offered thereby may differ from the terms set forth below.
GENERAL
The Debt Securities may be issued from time to time in one or more series of
Senior Debt Securities, Senior Subordinated Debt Securities and Subordinated
Debt Securities. The Indentures do not limit the aggregate principal amount of
Debt Securities which may be issued thereunder and provide that Debt Securities
of any series may be issued thereunder up to an aggregate principal amount which
may be authorized from time to time by the Company. Reference is made to the
applicable Prospectus Supplement relating to the series of Debt Securities
offered thereby for specific terms, including (where applicable): (1) the title
or designation of such Debt Securities; (2) any limit on the aggregate principal
amount of such Debt Securities; (3) the price or prices (which may be expressed
as a percentage of the principal amount thereof) at which such Debt Securities
will be issued; (4) the date or dates on which the principal of and premium, if
any, on such Debt Securities will be payable, or the method or methods, if any,
by which such date or dates will be determined; (5) the rate or rates (which may
be fixed or variable) at which such Debt Securities will bear interest, if any,
or the method or methods, if any, by which such rate or rates are to be
determined, the date or dates, if any, from which such interest will accrue, or
the method or methods, if any, by which such date or dates are to be determined,
and whether and under what circumstances Additional Amounts on such Debt
Securities will be payable, and the basis upon which interest will be calculated
if other than that of a 360-day year of twelve 30-day months; (6) the dates on
which such interest, if any, will be payable and the record dates therefor; (7)
the place or places where the principal of, premium, if any, and interest, if
any, on such Debt Securities will be payable and the place or places where such
Debt Securities may be surrendered for registration of transfer and exchange, if
other than The City of New York; (8) the date or dates on which, the period or
periods within which, the price or prices at which and the other terms and
conditions upon which such Debt Securities may be redeemed at the option of the
Company or are subject to repurchase at the option of the holders; (9) the terms
of any sinking fund or analogous provision; (10) if other than U.S. dollars, the
Currency for which the Debt Securities may be purchased and the Currency in
which the payment of principal thereof and premium, if any, and interest, if
any, thereon may be made, and the ability, if any, of the Company or the holders
of Debt Securities to have payments made in any Currency other than those in
which the Debt Securities are stated to be payable; (11) any addition to, or
modification or deletion of, any covenant or Event of Default with respect to
such Debt Securities; (12) whether any such Debt Securities are to be issuable
in registered or bearer form or both and, if in bearer form, the terms and
conditions relating thereto and any limitations on issuance of such Bearer
Securities (including in exchange for Registered Securities of the same series);
(13) whether any such Debt Securities will be issued in temporary or permanent
global form and, if so, the
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identity of the depositary for such global Debt Securities; (14) whether and
under what circumstances the Company will pay Additional Amounts (as
contemplated by the relevant Indenture) on such Debt Securities to any holder
who is a United States Alien (as defined in the relevant Indenture, as such
definition may be modified) in respect of any tax, assessment or other
governmental charge and, if so, whether the Company will have the option to
redeem such Debt Securities rather than pay such Additional Amounts; (15) the
person to whom any interest on any Registered Securities of the series shall be
payable, if other than the person in whose name such Registered Security (or one
or more Predecessor Securities) is registered at the close of business on the
Regular Record Date for such interest, the manner in which, or the person to
whom, any interest on any Bearer Security of the series shall be payable, if
other than upon presentation and surrender of the coupons appertaining thereto
as they severally mature, and the extent to which, or the manner in which, any
interest payable on a temporary global Debt Security will be paid if other than
in the manner provided in the relevant Indenture; (16) the portion of the
principal amount of such Debt Securities which shall be payable upon
acceleration thereof if other than the full principal amount thereof; (17) the
authorized denominations in which such Debt Securities will be issuable, if
other than denominations of $1,000 and any integral multiple thereof (in the
case of Registered Securities) or $5,000 (in the case of Bearer Securities);
(18) the terms, if any, upon which such Debt Securities may be convertible into
or exchangeable for other Securities; (19) whether such Debt Securities will be
Senior Debt Securities, Senior Subordinated Debt Securities or Subordinated Debt
Securities; (20) whether the amount of payments of principal of, premium, if
any, and interest, if any, on such Debt Securities may be determined with
reference to an index, formula or other method or methods (any such Debt
Securities being hereinafter called "Indexed Securities") and the manner in
which such amounts will be determined; and (21) any other terms of such Debt
Securities.
As used in this Prospectus and any Prospectus Supplement relating to the
offering of any Debt Securities, references to the principal of and premium, if
any, and interest, if any, on such Debt Securities will be deemed to include
mention of the payment of Additional Amounts, if any, required by the terms of
such Debt Securities in such context.
Debt Securities may be issued as Original Issue Discount Securities to be
sold at a substantial discount below their principal amount. In the event of an
acceleration of the maturity of any Original Issue Discount Security, the amount
payable to the holder thereof upon such acceleration will be determined in the
manner described in the applicable Prospectus Supplement. Material federal
income tax and other considerations applicable to Original Issue Discount
Securities will be described in the applicable Prospectus Supplement.
If the purchase price of any Debt Securities is payable in a currency other
than U.S. dollars or if principal of, or premium, if any, or interest, if any,
on any of the Debt Securities is payable in any currency other than U.S.
dollars, the specific terms and other information with respect to such Debt
Securities and such foreign currency will be specified in the Prospectus
Supplement relating thereto.
Under the Indentures, the terms of the Debt Securities of any series may
differ and, unless otherwise provided in the applicable Prospectus Supplement,
the Company, without the consent of the holders of the Debt Securities of any
series, may reopen a previous series of Debt Securities and issue additional
Debt Securities of such series or establish additional terms of such series.
REGISTRATION, TRANSFER, PAYMENT AND PAYING AGENT
Unless otherwise indicated in the applicable Prospectus Supplement, each
series of Debt Securities will be issued in registered form only, without
coupons. The Indentures, however, provide that the Company may also issue Debt
Securities in bearer form only, or in both registered and bearer form. Bearer
Securities shall not be offered, sold, resold or delivered in connection with
their original issuance in the United States or to any United States person (as
defined below) other than offices located outside the United States of certain
United States financial institutions. As used herein, "United States person"
means
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any citizen or resident of the United States, any corporation, partnership or
other entity created or organized in or under the laws of the United States, or
any estate or trust, the income of which is subject to United States federal
income taxation regardless of its source, and "United States" means the United
States of America (including the states thereof and the District of Columbia),
its territories, its possessions and other areas subject to its jurisdiction.
Purchasers of Bearer Securities will be subject to certification procedures and
may be affected by certain limitations under United States tax laws. Such
procedures and limitations will be described in the Prospectus Supplement
relating to the offering of any Bearer Securities.
Unless otherwise indicated in the applicable Prospectus Supplement,
Registered Securities will be issued in denominations of $1,000 or any integral
multiple thereof, and Bearer Securities will be issued in denominations of
$5,000.
Unless otherwise indicated in the applicable Prospectus Supplement, the
principal, premium, if any, and interest, if any, of or on the Debt Securities
will be payable, and Debt Securities may be surrendered for registration of
transfer or exchange, at an office or agency to be maintained by the Company in
the Borough of Manhattan, The City of New York, provided that payments of
interest with respect to any Registered Security may be made at the option of
the Company by check mailed to the address of the person entitled thereto or by
transfer to an account maintained by the payee with a bank located in the United
States. No service charge shall be made for any registration of transfer or
exchange of Debt Securities, but the Company may require payment of a sum
sufficient to cover any tax or other governmental charge that may be imposed in
connection therewith.
Unless otherwise indicated in the applicable Prospectus Supplement, payment
of the principal of, premium, if any, and interest, if any, on Bearer Securities
will be made, subject to any applicable laws and regulations, at such office or
agency outside the United States as specified in the Prospectus Supplement and
as the Company may designate from time to time. Unless otherwise indicated in
the applicable Prospectus Supplement, payment of interest due on Bearer
Securities on any Interest Payment Date will be made only against surrender of
the coupon relating to such Interest Payment Date. Unless otherwise indicated in
the applicable Prospectus Supplement, no payment of principal, premium or
interest with respect to any Bearer Security will be made at any office or
agency in the United States or by check mailed to any address in the United
States or by transfer to an account maintained with a bank located in the United
States; provided, however, that if amounts owing with respect to any Bearer
Securities shall be payable in U.S. dollars, payment with respect to any such
Bearer Securities may be made at the Corporate Trust Office of the applicable
Trustee or at any office or agency designated by the Company in the Borough of
Manhattan, The City of New York, if (but only if) payment of the full amount of
such principal, premium or interest at all offices outside of the United States
maintained for such purpose by the Company is illegal or effectively precluded
by exchange controls or similar restrictions.
Unless otherwise indicated in the applicable Prospectus Supplement, the
Company will not be required to (i) issue, register the transfer of or exchange
Debt Securities of any series during a period beginning at the opening of
business 15 days before any selection of Debt Securities of that series to be
redeemed and ending at the close of business on the day of that selection; (ii)
register the transfer of or exchange any Registered Security, or portion
thereof, called for redemption, except the unredeemed portion of any Registered
Security being redeemed in part; (iii) exchange any Bearer Security called for
redemption, except to exchange such Bearer Security for a Registered Security of
that series and like tenor that is simultaneously surrendered for redemption; or
(iv) issue, register the transfer of or exchange any Debt Security which has
been surrendered for repayment at the option of the holder, except the portion,
if any, of such Debt Security not to be so repaid.
RANKING OF DEBT SECURITIES
The Senior Debt Securities will be unsecured unsubordinated obligations of
the Company and will rank on a parity in right of payment with all other
unsecured and unsubordinated indebtedness of the
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Company. The Senior Subordinated Debt Securities will be unsecured senior
subordinated obligations of the Company and will be subordinated in right of
payment to all existing and future Senior Indebtedness (as defined in the
applicable Prospectus Supplement) of the Company, including the Senior Debt
Securities. The Subordinated Debt Securities will be unsecured subordinated
obligations of the Company and will be subordinated in right of payment to all
existing and future Senior Indebtedness (as defined in the applicable Prospectus
Supplement) of the Company, including the Senior Debt Securities and the Senior
Subordinated Debt Securities). See "--Subordination of Senior Subordinated and
Subordinated Debt Securities."
GLOBAL SECURITIES
The Debt Securities of a series may be issued in whole or in part in the
form of one or more global securities that will be deposited with, or on behalf
of, a depositary (the "Depositary") identified in the Prospectus Supplement
relating to such series. Global Debt Securities may be issued in either
registered or bearer form and in either temporary or permanent form. Unless and
until it is exchanged in whole or in part for individual certificates evidencing
Debt Securities in definitive form, a global Debt Security may not be
transferred except as a whole by the Depositary for such global Debt Security to
a nominee of such Depositary or by a nominee of such Depositary to such
Depositary or another nominee of such Depositary or by such Depositary or any
such nominee to a successor of such Depositary or a nominee of such successor.
The specific terms of the depositary arrangement with respect to any global
Debt Securities and certain limitations and restrictions relating to any global
Bearer Securities will be described in the applicable Prospectus Supplement.
OUTSTANDING DEBT SECURITIES
In determining whether the holders of the requisite principal amount of
outstanding Debt Securities have given any request, demand, authorization,
direction, notice, consent or waiver under the relevant Indenture, (i) the
portion of the principal amount of an Original Issue Discount Security that
shall be deemed to be outstanding for such purposes shall be that portion of the
principal amount thereof that could be declared to be due and payable upon a
declaration of acceleration thereof pursuant to the terms of such Original Issue
Discount Security as of the date of such determination, (ii) the principal
amount of any Indexed Security that shall be deemed to be outstanding for such
purpose shall be the principal face amount of such Indexed Security determined
on the date of its original issuance, (iii) the principal amount of a Debt
Security denominated in a currency other than U.S. dollars shall be the U.S.
dollar equivalent, determined on the date of original issue of such Debt
Security, of the principal amount of such Debt Security and (iv) any Debt
Security owned by the Company or any obligor on such Debt Security or any
Affiliate of the Company or such other obligor shall be deemed not to be
outstanding.
REDEMPTION AND REPURCHASE
The Debt Securities of any series may be redeemable at the option of the
Company, may be subject to mandatory redemption pursuant to a sinking fund or
otherwise, or may be subject to repurchase by the Company at the option of the
holders, in each case upon the terms, at the times and at the prices set forth
in the applicable Prospectus Supplement.
CONVERSION AND EXCHANGE
The terms, if any, on which Debt Securities of any series are convertible
into or exchangeable for Common Stock, Preferred Stock or other Debt Securities
will be set forth in the applicable Prospectus Supplement. Such terms may
include provisions for conversion or exchange, either mandatory, at the option
of the holders or at the option of the Company.
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CERTAIN COVENANTS OF THE COMPANY
The following covenant will be contained in each of the Indentures. Any
additional covenants applicable to any series of Debt Securities will be set
forth in the applicable Prospectus Supplement.
MERGER, SHARE EXCHANGE AND SALE OF ASSETS. Each Indenture provides that the
Company will not, in any transaction or series of transactions, merge or enter
into a share exchange with, or sell, assign, convey, transfer, lease or
otherwise dispose of all or substantially all of its properties and assets as
to, any person or persons, and the Company will not permit any of its
Subsidiaries (as defined in the applicable Prospectus Supplement) to enter into
any such transaction or series of transactions if such transaction or series of
transactions, in the aggregate, would result in a sale, assignment, conveyance,
transfer, lease or other disposition of all or substantially all of the
properties and assets of the Company or the Company and its Subsidiaries, taken
as a whole, to any other person or persons, unless at the time of and after
giving effect thereto (a) either (i) if the transaction or series of
transactions is a merger or share exchange, the Company shall be the surviving
person of such merger or consolidation, or (ii) the person formed by such share
exchange or into which the Company or such Subsidiary is merged or to which the
properties and assets of the Company or such Subsidiary, as the case may be, are
transferred (any such surviving person or transferee person being the "Surviving
Entity") shall be a corporation organized and existing under the laws of the
United States of America, any state thereof or the District of Columbia and
shall expressly assume by a supplemental indenture executed and delivered to the
Trustee, in form reasonably satisfactory to the Trustee, all of the obligations
of the Company under the relevant Debt Securities and Indenture; (b) immediately
after giving effect to such transaction, no Event of Default under such
Indenture, and no event which, after notice or lapse of time or both would
become an Event of Default under such Indenture, shall have happened and be
continuing; and (c) certain other conditions (including such as may be specified
in the applicable Prospectus Supplement) are met.
Upon any such merger, share exchange, sale, assignment, conveyance,
transfer, lease or other disposition in which the Company is not the continuing
corporation, the successor corporation formed by such consolidation or into
which the Company is merged or to which such sale, assignment, conveyance,
transfer, lease or other disposition is made shall succeed to, and be
substituted for, and may exercise every right and power of, the Company under
the relevant Indenture with the same effect as if such successor corporation had
been named as the Company therein and thereafter (except in the case of a lease)
the Company shall be released from its obligations under such Indenture and the
Debt Securities.
EVENTS OF DEFAULT
An Event of Default with respect to the Debt Securities of any series is
defined in the relevant Indenture as being: (i) default in the payment of any
interest on any of the Debt Securities of such series (or any Additional Amounts
payable in respect of such interest) when the same becomes due and payable and
continuance of such default for 30 days; (ii) default in the payment of any
principal of or premium, if any, on any Debt Security of such series (or any
Additional Amounts payable in respect of such principal or premium) when the
same becomes due and payable (whether at stated maturity, upon acceleration,
optional redemption, required purchase, scheduled principal payment or
otherwise); (iii) default in making any sinking fund payment or payment under
any analogous provision when due with respect to any Debt Security of such
series; (iv) default by the Company in the performance, or breach, of any other
covenant or warranty in the relevant Indenture (other than a covenant or
warranty included therein solely for the benefit of a series of Debt Securities
other than that series) or any Debt Security of such series which shall not have
been remedied for a period of 30 days after notice to the Company by the
relevant Trustee or the holders of not less than 25% in aggregate principal
amount of the Debt Securities of such series then outstanding; (v) certain
events of bankruptcy, insolvency or reorganization with respect to the Company
or any Significant Subsidiary (as defined in the applicable Prospectus
Supplement) of the Company; and (vi) any other Event of Default provided with
respect to Debt Securities of that series as described in the applicable
Prospectus Supplement. Each Indenture provides that the Trustee thereunder may
withhold
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notice to the holders of the Debt Securities of any series of the occurrence of
a default with respect to the Debt Securities of such series (except a default
in payment of principal, premium, if any, interest, if any, or sinking fund
payments, if any) if the Trustee considers it in the interest of the holders to
do so.
Each Indenture provides that if an Event of Default (other than as specified
in clause (vi) above) with respect to any series of Debt Securities issued
thereunder shall have occurred and be continuing, either the relevant Trustee or
the holders of at least 25% in principal amount of the Debt Securities of such
series then outstanding may declare the principal of (or if any Debt Securities
of such series are Original Issue Discount Securities, such lesser amount as may
be specified in the terms thereof) and accrued and unpaid interest, if any, on
all of the Debt Securities of such series to be due and payable immediately;
and, if an Event of Default specified in clause (vi) above occurs and is
continuing, the principal of (or if any Debt Securities of such series are
Original Issue Discount Securities, such lesser amount as may be specified in
the terms thereof) and accrued and unpaid interest, if any, on all of the Debt
Securities of such series shall become due and payable immediately without any
declaration or other act on the part of the Trustee or the holders thereof. Upon
certain conditions such acceleration may be annulled by the holders of a
majority in principal amount of the Debt Securities of such series then
outstanding.
Subject to the provisions of the Trust Indenture Act of 1939 requiring each
Trustee, during an Event of Default under the relevant Indenture, to act with
the requisite standard of care, a Trustee is under no obligation to exercise any
of its rights or powers under the relevant Indenture at the request or direction
of any of the holders of Debt Securities of any series unless such holders have
offered such Trustee reasonable indemnity. Subject to the foregoing, holders of
a majority in principal amount of the then outstanding Debt Securities of any
series issued under an Indenture shall have the right, subject to certain
limitations, to direct the time, method and place of conducting any proceeding
for any remedy available to the Trustee under such Indenture with respect to
such series. Each Indenture requires the annual filing by the Company with the
relevant Trustee of a certificate as to whether or not the Company is in default
under the terms of such Indenture.
MODIFICATION, WAIVERS AND MEETINGS
Each Indenture contains provisions permitting the Company and the Trustee
thereunder, with the consent of the holders of a majority in principal amount of
the outstanding Debt Securities of each series issued under such Indenture and
affected by a modification or amendment, to modify or amend any of the
provisions of such Indenture or of the Debt Securities of such series or the
rights of the holders of the Debt Securities of such series under such
Indenture, provided that no such modification or amendment shall, among other
things, (i) change the stated maturity of the principal of, or premium, if any,
or any installment of interest, if any, on any Debt Securities issued under such
Indenture or reduce the principal amount thereof or any premium thereon, or
reduce the rate of interest thereon, or reduce the amount of principal of any
Original Issue Discount Securities that would be due and payable upon an
acceleration of the maturity thereof, or adversely affect any right of repayment
at the option of any holder, or change any place where, or the currency in
which, any Debt Securities issued under such Indenture are payable, or impair
the holder's right to institute suit to enforce the payment of any such Debt
Securities, or make any change that adversely affects the right, if any, to
convert or exchange such Debt Securities for other securities in accordance with
their terms, or (ii) reduce the aforesaid percentage of Debt Securities of any
series issued under such Indenture, the consent of the holders of which is
required for any such modification or amendment or the consent of whose holders
is required for any waiver (of compliance with certain provisions of such
Indenture or certain defaults thereunder and their consequences) or reduce the
requirements for a quorum or voting at a meeting of holders of such Debt
Securities or (iii) solely in the case of the Senior Subordinated Indenture and
the Subordinated Indenture, modify any of the provisions of the specific Article
in such Indenture relating to subordination of the Debt Securities issued under
such Indenture or the definition of Senior Indebtedness therein in a manner
adverse to the holders of the Debt Securities issued under such Indenture,
without in each such case obtaining the consent of the holder of
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each outstanding Debt Security issued under such Indenture so affected. Each
Indenture also contains provisions permitting the Company and the relevant
Trustee, without the consent of the holders of any Debt Securities issued
thereunder, to modify or amend such Indenture in order to, among other things,
(a) add to the Events of Default or the covenants of the Company for the benefit
of the holders of all or any series of Debt Securities issued under such
Indenture; (b) to add or change any provisions of such Indenture to facilitate
the issuance of Bearer Securities; (c) to establish the form or terms of Debt
Securities of any series and any related coupons; (d) to cure any ambiguity or
correct or supplement any provision therein which may be inconsistent with other
provisions therein, or to make any other provisions with respect to matters or
questions arising under such Indenture which shall not adversely affect the
interests of the holders of any series of Debt Securities issued thereunder in
any material respect; or (e) to amend or supplement any provision contained in
such Indenture, provided that such amendment or supplement does not apply to any
outstanding Debt Securities issued prior to the date of such amendment or
supplement and entitled to the benefits of such provision.
The holders of a majority in aggregate principal amount of the outstanding
Debt Securities of any series may waive compliance by the Company with certain
restrictive provisions of the relevant Indenture. The Holders of a majority in
aggregate principal amount of the outstanding Debt Securities of any series may,
on behalf of all holders of Debt Securities of that series, waive any past
default under the applicable Indenture with respect to Debt Securities of that
series and its consequences, except a default in the payment of the principal
of, or premium, if any, or interest, if any, on any Debt Securities of such
series or in respect of a covenant or provision which cannot be modified or
amended without the consent of the holder of each outstanding Debt Securities of
such series affected.
Each Indenture contains provisions for convening meetings of the holders of
Debt Securities of a series issued thereunder. A meeting may be called at any
time by the relevant Trustee, and also, upon request, by the Company or the
holders of at least 10% in principal amount of the outstanding Debt Securities
of such series, in any such case upon notice given in accordance with the
provisions of such Indenture. Except for any consent which must be given by the
holder of each outstanding Debt Security affected thereby, as described above,
any resolution presented at a meeting or adjourned meeting duly reconvened at
which a quorum (as described below) is present may be adopted by the affirmative
vote of the holders of a majority in principal amount of the outstanding Debt
Securities of that series; provided, however, that (i) any resolution with
respect to any request, demand, authorization, direction, notice, consent,
waiver or other action which may be made, given or taken by the holders of a
specified percentage, which is less than a majority, in principal amount of the
outstanding Debt Securities of a series and (ii) any resolution with respect to
any request, demand, authorization, direction, notice, consent, waiver or other
action which may be made, given or taken by the holders of a specified
percentage, which is more than a majority, in principal amount of the
outstanding Debt Securities of a series, may be adopted at a meeting or
adjourned meeting duly reconvened at which a quorum is present by the
affirmative vote of the holders of such specified percentage in principal amount
of the outstanding Debt Securities of that series. Any resolution passed or
decision taken at any meeting of holders of Debt Securities of any series duly
held in accordance with the relevant Indenture will be binding on all holders of
Debt Securities of that series and the related coupons. The quorum at any
meeting called to adopt a resolution, and at any reconvened meeting, will be
persons holding or representing a majority in principal amount of the
outstanding Debt Securities of a series, subject to certain exceptions.
DISCHARGE, DEFEASANCE AND COVENANT DEFEASANCE
Upon the direction of the Company, any Indenture shall cease to be of
further effect with respect to any series of Debt Securities issued thereunder
specified by the Company (subject to the survival of certain provisions thereof,
including the obligation to pay Additional Amounts to the extent described
below) when (i) either (A) all outstanding Debt Securities of such series and,
in the case of Bearer Securities, all coupons appertaining thereto, have been
delivered to the relevant Trustee for cancellation (subject to
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certain exceptions) or (B) all Debt Securities of such series have become due
and payable or have been called for redemption and the Company has deposited
with the Trustee, in trust, funds in U.S. dollars or in such foreign currency in
which such Debt Securities are payable in an amount sufficient to pay the entire
indebtedness on such Debt Securities in respect of principal, premium, if any,
and interest, if any (and, to the extent that (x) the Debt Securities of such
series provide for the payment of Additional Amounts upon the occurrence of
certain events of taxation, assessment or governmental charge with respect to
payments on such Debt Securities and (y) the amount of any such Additional
Amounts is at the time of deposit reasonably determinable by the Company (in the
exercise of its sole discretion), any such Additional Amounts) to the date of
such deposit (if such Debt Securities have become due and payable) or to the
date fixed for redemption thereof, as the case may be, (ii) the Company has paid
all other sums payable under the Indenture with respect to the Debt Securities
of such series, and (iii) certain other conditions (including such as may be
specified in the applicable Prospectus Supplement) are met. If the Debt
Securities of any such series provide for the payment of Additional Amounts, the
Company will remain obligated, following such deposit, to pay Additional Amounts
on such Debt Securities to the extent that the amount thereof exceeds the amount
deposited in respect of such Additional Amounts as aforesaid.
Unless otherwise provided in the applicable Prospectus Supplement, the
Company may elect with respect to any series of Debt Securities either (a) to
defease and be discharged from any and all obligations with respect to such Debt
Securities (except for, among other things, the obligation to pay Additional
Amounts, if any, upon the occurrence of certain events of taxation, assessment
or governmental charge with respect to payments on such Debt Securities to the
extent that the amount thereof exceeds the amount deposited in respect of such
Additional Amounts as provided below, and the obligations to register the
transfer or exchange of such Debt Securities, to replace temporary or mutilated,
destroyed, lost or stolen Debt Securities, to maintain an office or agency in
respect of such Debt Securities, to hold moneys for payment in trust, and, if
applicable, to exchange or convert such Debt Securities into other securities in
accordance with their terms) ("defeasance"), or (b) to be released from its
obligations under certain covenants applicable to such Debt Securities (which
covenants will be described in the applicable Prospectus Supplement), and any
omission to comply with such obligations shall not constitute a default or an
Event of Default with respect to the Debt Securities of such series ("covenant
defeasance"), in either case upon the irrevocable deposit with the relevant
Trustee (or other qualifying trustee), in trust for such purpose, of an amount,
in U.S. dollars or in such foreign currency in which such Debt Securities are
payable at stated maturity, and/or Government Obligations (as defined in the
relevant Indenture) which through the payment of principal and interest in
accordance with their terms will provide money, in an amount sufficient to pay
the principal of and premium, if any, and interest, if any, on (and, to the
extent that (x) the Debt Securities of such series provide for the payment of
Additional Amounts and (y) the amount of any such Additional Amounts is at the
time of deposit reasonably determinable by the Company (in the exercise of its
sole discretion), any such Additional Amounts with respect to) such Debt
Securities, and any mandatory sinking fund or analogous payments thereon, on the
due dates therefor, whether upon maturity, redemption or otherwise.
Such defeasance or covenant defeasance shall only be effective if, among
other things, (i) the Company shall have delivered to the relevant Trustee an
opinion of counsel to the effect that the holders of the outstanding Debt
Securities of such series will not recognize income, gain or loss for federal
income tax purposes as a result of such defeasance or covenant defeasance and
will be subject to federal income tax on the same amounts, in the same manner
and at the same times as would have been the case if such legal defeasance or
covenant defeasance had not occurred (in the case of defeasance, such opinion
must refer to and be based upon a ruling of the Internal Revenue Service or a
change in applicable federal income tax laws); (ii) no Event of Default or event
which, with notice or lapse of time or both, would constitute an Event of
Default under the relevant Indenture shall have occurred and be continuing on
the date of such deposit or, insofar as clause (vi) of the first paragraph under
"--Events of Default" is concerned, at any time during the period ending on the
123rd day after the date of such deposit (it being understood that this
condition shall not be deemed satisfied until the expiration of such period);
(iii) such defeasance or
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covenant defeasance shall not cause such Trustee to have a conflicting interest
with respect to any securities of the Company; (iv) such defeasance or covenant
defeasance shall not result in a breach or violation of, or constitute a default
under, such Indenture or any other material agreement or instrument to which the
Company or any Subsidiary is a party or by which the Company or any Subsidiary
is bound; (v) the Company shall have delivered to such Trustee an opinion of
counsel to the effect that after the 123rd day following the deposit, the trust
funds will not be subject to avoidance or recovery under any applicable
bankruptcy laws; and (vi) the Company shall have satisfied certain further
conditions, including delivery to the Trustee of an officers' certificate and an
opinion of counsel, each stating that all conditions precedent under such
Indenture to such defeasance or covenant defeasance, as the case may be, have
been complied with.
Unless otherwise provided in the applicable Prospectus Supplement, if after
the Company has deposited funds and/or Government Obligations to effect
defeasance or covenant defeasance with respect to Debt Securities of any series,
(a) the holder of a Debt Security of such series is entitled to, and does, elect
pursuant to the applicable Indenture or the terms of such Debt Security to
receive payment in a currency other than that in which such deposit has been
made in respect of such Debt Security, or (b) a Conversion Event (as defined
below) occurs in respect of the foreign currency in which such deposit has been
made, the indebtedness represented by such Debt Security shall be deemed to have
been, and will be, fully discharged and satisfied through the payment of the
principal of, premium, if any, and interest, if any, on such Debt Security as
such Debt Security becomes due out of the proceeds yielded by converting the
amount so deposited in respect of such Debt Security into the currency in which
such Debt Security becomes payable as a result of such election or such
Conversion Event based on (x) in the case of payments made pursuant to clause
(a) above, the applicable market exchange rate for such foreign currency in
effect on the second business day prior to such payment date, or (y) with
respect to a Conversion Event, the applicable market exchange rate for such
foreign currency in effect (as nearly as feasible) at the time of the Conversion
Event.
"Conversion Event" means the cessation of use of (i) a foreign currency both
by the government of the country or the confederation which issued such foreign
currency and for the settlement of transactions by a central bank or other
public institutions of or within the international banking community, (ii) the
ECU both within the European Monetary System and for the settlement of
transactions by public institutions of or within the European Union or (iii) any
currency unit or composite currency other than the ECU for the purposes for
which it was established.
In the event the Company effects covenant defeasance with respect to any
Debt Securities and such Debt Securities are declared due and payable because of
the occurrence of any Event of Default (including any Event of Default with
respect to any covenant as to which such covenant defeasance is not applicable),
the amount of monies and/or Government Obligations deposited with the applicable
Trustee to effect such covenant defeasance may not be sufficient to pay amounts
due on such Debt Securities at the time of any acceleration resulting from such
Event of Default. However, the Company would remain liable to make payment of
such amounts due at the time of acceleration.
The applicable Prospectus Supplement may further describe the provisions, if
any, permitting or restricting defeasance or covenant defeasance with respect to
the Debt Securities of a particular series.
GOVERNING LAW
The Indentures and the Debt Securities will be governed by, and construed in
accordance with, the laws of the State of New York.
REGARDING THE TRUSTEES
The Trust Indenture Act of 1939 contains limitations on the rights of a
trustee, should it become a creditor of the Company, to obtain payment of claims
in certain cases or to realize on certain property
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received by it in respect of any such claims, as security or otherwise. Each
Trustee is permitted to engage in other transactions with the Company and its
subsidiaries from time to time, provided that if such Trustee acquires any
conflicting interest it must eliminate such conflict upon the occurrence of an
Event of Default under the relevant Indenture, or else resign.
SUBORDINATION OF SENIOR SUBORDINATED AND SUBORDINATED DEBT SECURITIES
The payment of the principal of, premium, if any, and interest, if any, on
the Senior Subordinated Debt Securities and the Subordinated Debt Securities
will be subordinated, to the extent and in the manner set forth in the Senior
Subordinated Indenture and Subordinated Indenture, respectively, and as may be
further described in the applicable Prospectus Supplement, in right of payment
to the prior payment in full in cash or Cash Equivalents of all Senior
Indebtedness which may at any time and from time to time be outstanding.
Unless otherwise provided in the applicable Prospectus Supplement with
respect to an issue of Senior Subordinated Debt Securities or Subordinated Debt
Securities, in the event of any insolvency or bankruptcy case or proceeding, or
any receivership, liquidation, reorganization or other similar case or
proceeding in connection therewith, relating to the Company or its assets, or
any liquidation, dissolution or other winding-up of the Company, whether
voluntary or involuntary, or any assignment for the benefit of creditors or
other marshalling of assets or liabilities of the Company, all Senior
Indebtedness of the Company must be paid in full or such payment must be
provided for before any payment or distribution (excluding the distribution of
certain permitted equity or subordinated securities) is made on account of the
principal, premium, if any, sinking fund, if any, or interest, if any, on any
Senior Subordinated Debt Securities or Subordinated Debt Securities, as the case
may be.
In addition, the applicable Prospectus Supplement may provide that no
payment on account of the Senior Subordinated Debt Securities or Subordinated
Debt Securities offered thereby shall be made during the continuance of certain
defaults with respect to the Senior Indebtedness or certain designated Senior
Indebtedness of the Company.
In the event that, notwithstanding the foregoing, any payment or
distribution of assets (excluding the distribution of certain permitted equity
or subordinated securities) of the Company is received by the Senior
Subordinated Trustee or the Subordinated Trustee or the holders of any of the
Senior Subordinated Debt Securities or Subordinated Debt Securities, as the case
may be, under the circumstances described above and before all Senior
Indebtedness is paid in full, such payment or distribution will be paid over to
the holders of such Senior Indebtedness or on their behalf for application to
the payment of all such Senior Indebtedness remaining unpaid until all such
Senior Indebtedness has been paid in full or such payment provided for, after
giving effect to any concurrent payment or distribution to the holders of such
Senior Indebtedness.
If the Company fails to make any payments on the Senior Subordinated Debt
Securities or the Subordinated Debt Securities of any series when due or within
any applicable grace period, whether or not on account of any payment blockage
provisions that may be set forth in the applicable Prospectus Supplement, such
failure would constitute an Event of Default under the relevant Indenture and
would enable the holders of such Debt Securities to accelerate the maturity
thereof. See "--Events of Default."
By reason of such subordination, in the event of any distribution of assets
of the Company upon dissolution, winding up, liquidation, reorganization or
other similar proceedings of the Company, (i) holders of Senior Indebtedness
will be entitled to be paid in full before payments may be made on the Senior
Subordinated Debt Securities or the Subordinated Debt Securities and the holders
of Senior Subordinated Debt Securities and Subordinated Debt Securities will be
required to pay over their share of such distribution to the holders of Senior
Indebtedness until such Senior Indebtedness is paid in full and (ii) creditors
of the Company who are neither holders of Senior Subordinated Debt Securities or
Subordinated Debt Securities nor holders of Senior Indebtedness may recover
less, ratably, than holders of
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Senior Indebtedness and may recover more, ratably, than the holders of the
Senior Subordinated Debt Securities and Subordinated Debt Securities.
Furthermore, such subordination may result in a reduction or elimination of
payments to the holders of Senior Subordinated Debt Securities and Subordinated
Debt Securities. The Senior Subordinated Indenture and Subordinated Indenture
provide that the subordination provisions thereof will not apply to any money
and securities held in trust pursuant to the discharge, defeasance and covenant
defeasance provisions of such Indenture (see "--Discharge, Defeasance and
Covenant Defeasance" above).
If this Prospectus is being delivered in connection with the offering of a
series of Senior Subordinated Debt Securities or Subordinated Debt Securities,
the accompanying Prospectus Supplement or the information incorporated by
reference herein will set forth the definition of Senior Indebtedness applicable
thereto and the approximate amount of such Senior Indebtedness outstanding as of
a recent date.
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DESCRIPTION OF PREFERRED STOCK
The following description of the terms of the Preferred Stock sets forth
certain general terms and provisions of the Preferred Stock to which any
Prospectus Supplement may relate. Certain terms of a series of the Preferred
Stock offered by any Prospectus Supplement will be described in the Prospectus
Supplement relating to such series of the Preferred Stock. If so indicated in
the Prospectus Supplement, the terms of any such series may differ from the
terms set forth below. The following description of the Preferred Stock
summarizes certain provisions of the Articles of Incorporation of QFC (the
"Articles") and is subject to and qualified in its entirety by reference to the
Articles and any actual Articles of Amendment which will be filed with the SEC
promptly after any offering of such series of Preferred Stock.
GENERAL
The Articles authorize 1,000,000 shares of Preferred Stock and permits the
Board of Directors, without further shareholder authorization, to issue
Preferred Stock in one or more series and to fix the terms and provisions of
each series, including dividend rights and preferences over dividends on the
Common Stock; conversion rights, if any; voting rights, if any (in addition to
those provided by law); redemption rights, if any, and the terms of any sinking
fund therefor; and rights on liquidation, including preferences over the Common
Stock, which action could adversely affect the rights of holders of Common
Stock.
As of the date of this Prospectus, QFC has no shares of Preferred Stock
outstanding. QFC may amend from time to time, with shareholder approval, the
Articles to increase the number of authorized shares of Preferred Stock.
The Preferred Stock will have the dividend, liquidation, redemption and
voting rights set forth below unless otherwise provided in the Prospectus
Supplement relating to a particular series of the Preferred Stock. Reference is
made to the Prospectus Supplement relating to the particular series of the
Preferred Stock offered thereby for specific terms, including: (i) the
designation of such Preferred Stock, the number of shares offered and the
liquidation value thereof; (ii) the price at which such Preferred Stock will be
issued; (iii) the dividend rate (or method of calculation), the dates on which
dividends shall be payable, whether such dividends shall be cumulative or
noncumulative and, if cumulative, the dates from which dividends shall commence
to accumulate; (iv) the liquidation preference thereof; (v) any redemption or
sinking fund provisions; (vi) any conversion or exchange provisions of such
Preferred Stock; and (vii) any additional dividend, liquidation, redemption,
sinking fund and other rights, preferences, limitations and restrictions of such
Preferred Stock.
The Preferred Stock will, when issued, be fully paid and nonassessable.
Unless otherwise specified in the Prospectus Supplement relating to a particular
series of the Preferred Stock, each series of the Preferred Stock will rank on a
parity as to dividends and distributions in the event of a liquidation with each
other series of the Preferred Stock, if any. Holders of Preferred Stock will
have no preemptive rights to subscribe for or purchase shares of capital stock.
DIVIDEND RIGHTS
Holders of the Preferred Stock of each series will be entitled to receive,
when, as and if declared by the Board of Directors, out of assets of QFC legally
available therefor, cash dividends at such rates and on such dates as are set
forth in the Prospectus Supplement relating to such series of the Preferred
Stock. Such rate may be fixed or variable or both. Each such dividend will be
payable to the holders of record as they appear on the stock books of QFC on
such record dates as will be fixed by the Board of Directors. Dividends on any
series of the Preferred Stock may be cumulative or noncumulative, as provided in
the Prospectus Supplement relating thereto. If the Board of Directors fails to
declare a dividend payable on a dividend payment date on any series of Preferred
Stock for which dividends are noncumulative, then the right to receive a
dividend in respect of the dividend period ending on such dividend payment date
will be
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lost, and QFC shall have no obligation to pay the dividend accrued for that
period, whether or not dividends are declared for any future period.
No full dividends will be declared or paid or set apart for payment on
preferred stock of any series ranking, as to dividends, on a parity with or
junior to any series of Preferred Stock for any period unless full dividends
have been or contemporaneously are declared and paid, or declared and a sum
sufficient for the payment thereof set apart for such payment on such series of
Preferred Stock for the then-current dividend period and, if such Preferred
Stock is cumulative, all other dividend periods terminating on or before the
date of payment of such full dividends. When dividends are not paid in full upon
any series of the Preferred Stock and any other preferred stock ranking on a
parity as to dividends with such series of the Preferred Stock, all dividends
declared upon such series of the Preferred Stock and any other preferred stock
ranking on a parity as to dividends will be declared PRO RATA so that the amount
of dividends declared per share on such series of the Preferred Stock and such
other preferred stock will in all cases bear to each other the same ratio that
accrued dividends, including, in the case of cumulative Preferred Stock,
accumulations, if any, in respect of prior dividend periods, per share on such
series of the Preferred Stock and such other preferred stock bear to each other.
Except as provided in the preceding sentence, unless full dividends, including,
in the case of cumulative Preferred Stock, accumulations, if any, in respect of
prior dividend periods, on all outstanding shares of any series of the Preferred
Stock have been paid or declared and set aside for payment, no dividends (other
than a dividend or distribution paid in shares of, or warrants, rights or
options exercisable for or convertible into, Common Stock or another stock
ranking junior to such series of the Preferred Stock as to dividends and upon
liquidation) will be declared or paid or set aside for payment or other
distributions made upon the Common Stock or any other stock of QFC ranking
junior to or on a parity with the Preferred Stock as to dividends or upon
liquidation, nor will any Common Stock or any other stock of QFC ranking junior
to or on a parity with such series of the Preferred Stock as to dividends or
upon liquidation be redeemed, purchased or otherwise acquired for any
consideration (or any moneys be paid to or made available for a sinking fund for
the redemption of any shares of any such stock) by QFC (except by conversion
into or exchange for stock of QFC ranking junior to such series of the Preferred
Stock as to dividends and upon liquidation). No interest, or sum of money in
lieu of interest, shall be payable in respect of any dividend payment or
payments which may be in arrears.
Except as set forth in the Prospectus Supplement relating to a series of
Preferred Stock, the amount of dividends payable for each dividend period will
be computed by annualizing the applicable dividend rate and dividing by the
number of dividend periods in a year, except that the amount of dividends
payable for the initial dividend period or any period longer or shorter than a
full dividend period shall be computed on the basis of 30-day months and a
360-day year.
Each series of Preferred Stock will be entitled to dividends as described in
the Prospectus Supplement relating to such series, which may be based upon one
or more methods of determination. Different series of the Preferred Stock may be
entitled to dividends at different dividend rates or based upon different
methods of determination.
RIGHTS UPON LIQUIDATION
In the event of any voluntary or involuntary liquidation, dissolution or
winding up of QFC, the holders of each series of Preferred Stock will be
entitled to receive out of assets of QFC available for distribution to
shareholders, before any distribution of assets is made to holders of Common
Stock or any other class of stock ranking junior to such series of the Preferred
Stock upon liquidation, liquidating distributions in the amount set forth in the
Prospectus Supplement relating to such series of the Preferred Stock plus an
amount equal to accrued and unpaid dividends for the then-current dividend
period and, if such series of the Preferred Stock include cumulative rights to
dividends, for all dividend periods prior thereto. If, upon any voluntary or
involuntary liquidation, dissolution or winding up of QFC, the amounts payable
with respect to the Preferred Stock of any series and any other shares of stock
of QFC ranking as to any such distribution on a parity with such series of the
Preferred Stock are not paid in full, the holders of the
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Preferred Stock of such series and of such other shares will share ratably in
any such distribution of assets of QFC in proportion to the full respective
preferential amounts to which they are entitled. After payment of the full
amount of the liquidating distribution to which they are entitled, the holders
of such series of Preferred Stock will have no right or claim to any of the
remaining assets of QFC. Neither the sale of all or substantially all the
property or business of QFC nor the merger or share exchange of QFC with or into
any other corporation shall be deemed to be a dissolution, liquidation or
winding up, voluntary or involuntary, of QFC.
REDEMPTION
A series of the Preferred Stock may be redeemable, in whole or in part, at
the option of QFC, and may be subject to mandatory redemption pursuant to a
sinking fund, in each case upon terms, at the times and at the redemption prices
set forth in the Prospectus Supplement relating to such series.
The Prospectus Supplement relating to a series of Preferred Stock which is
subject to mandatory redemption will specify the number of shares of such series
of Preferred Stock which will be redeemed by QFC in each year commencing after a
date to be specified, at a redemption price per share to be specified, together
with an amount equal to any accrued and unpaid (cumulative or non-cumulative, as
the case may be) dividends thereon to the date of redemption. The redemption
price may be payable in cash, capital stock or in cash received from the net
proceeds of the issuance of capital stock of QFC, as specified in the Prospectus
Supplement relating to such series of Preferred Stock.
If fewer than all the outstanding shares of any series of the Preferred
Stock are to be redeemed, whether by mandatory or optional redemption, the
selection of the shares to be redeemed will be determined by lot or PRO RATA as
may be determined by the Board of Directors or by any other method which may be
determined by the Board of Directors to be equitable. From and after the date of
redemption (unless default shall be made by QFC in providing for the payment of
the redemption price), dividends shall cease to accrue on the shares of
Preferred Stock called for redemption and, subject to compliance with Section
23B.06.030(3) of the Washington Business Corporation Act (the "Washington
Business Corporation Act") all rights of the holders thereof (except the right
to receive the redemption price) shall cease.
In the event that full dividends, including accumulations in the case of
cumulative Preferred Stock, on any series of the Preferred Stock have not been
paid, such series of the Preferred Stock may not be redeemed in part and QFC may
not purchase or acquire any shares of such series of the Preferred Stock
otherwise than pursuant to a purchase or exchange offer made on the same terms
to all holders of such series of the Preferred Stock.
CONVERSION OR EXCHANGE RIGHTS
The Prospectus Supplement for any series of the Preferred Stock will state
the terms, if any, on which shares of such series are convertible into, or
exchangeable for, securities of QFC or another person.
VOTING RIGHTS
The Prospectus Supplement for any series of the Preferred Stock will state
the voting rights, if any, including any voting rights expressly required by
applicable law, of the holders of any such series of Preferred Stock.
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DESCRIPTION OF COMMON STOCK
The following description of the terms of the Common Stock summarizes
certain provisions of the Washington Business Corporation Act and the Articles
and is subject to and qualified in its entirety by reference to such provisions
and documents.
GENERAL
The Articles currently authorize the issuance of up to 60,000,000 shares of
Common Stock. The holders of Common Stock are entitled to receive dividends
when, as and if declared by the Board of Directors out of any funds lawfully
available therefor and, in the event of liquidation or distribution of assets,
are entitled to participate ratably in the distribution of such assets remaining
after payment of liabilities, in each case subject to any preferential rights
granted to any series of Preferred Stock that may then be outstanding. The
Common Stock does not have any preemptive rights. The issued and outstanding
shares of Common Stock are fully paid and nonassessable.
Holders of the shares of Common Stock are entitled to vote in person or by
proxy at all meetings of shareholders of the Company for the election of
directors and for other purposes. Such holders have one vote for each share of
Common Stock held by them. In voting for directors, the Common Stock does not
have cumulative voting rights. The Company's directors are divided into three
classes of approximately equal size and are elected for staggered terms of three
years, with one such class being elected at each annual meeting of shareholders.
PROVISIONS AFFECTING ACQUISITION OF THE COMPANY
Except as otherwise described below (and in addition to any voting rights
granted to or held by holders of Preferred Stock) the approval of any merger,
share exchange, sale, lease, exchange or disposition of all or substantially all
of QFC's property, otherwise than in the usual and regular course of business,
or proposal to dissolve, requires the affirmative vote of the holders of not
less than a majority of the outstanding shares of voting stock. In addition, the
Articles provide that (i) any merger, consolidation, combination or
reorganization of the Company with or into any person who, together with its
affiliates or associates or any group of persons that has agreed to act
together, is or becomes the beneficial owner of five percent or more of the
Company's outstanding voting stock who did not, on March 4, 1987, own five
percent or more of the Company's voting stock (an "Interested Person"), (ii) any
sale, lease, exchange, transfer, liquidation or other disposition of more than
ten percent of the Fair Market Value (as defined in the Articles) of the total
consolidated assets of the Company to an Interested Person, (iii) any sale,
lease, exchange, transfer, liquidation or other disposition of more than ten
percent of the Fair Market Value of the total consolidated assets of an
Interested Person to the Company, (iv) any issuance or transfer of any
securities of the Company (other than by way of a pro rata distribution to all
shareholders) to an Interested Person which, when aggregated with all prior
issuances and transfers to such Interested Person of securities of the Company
during the preceding 365 days, constitutes five percent or more of the
outstanding shares of any class or series of securities of the Company, (v) any
acquisition by the Company of one percent or more of any outstanding class or
series of debt or equity securities of an Interested Person, (vi) any
recapitalization or reorganization that would have the effect of increasing the
voting power of an Interested Person and (vii) any agreement or other
arrangement for any of the foregoing transactions (collectively, a "Business
Combination"), must be approved by the vote of at least 66 2/3% of the
outstanding voting stock of the Company, unless the proposed Business
Combination is (a) approved by a majority of the directors ("Continuing
Directors") who are unaffiliated with such Interested Person and are not such
Interested Person and who were directors before such Interested Person became an
Interested Person or who were elected or nominated by a majority of the
Continuing Directors or (b) structured to provide for payment of cash or other
consideration to the Company's shareholders in a manner which satisfies certain
requirements of the Articles (the "Fair Price Requirements").
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The Fair Price Requirements provide that a Business Combination must provide
for an offer to all holders of each class of equity securities of either cash or
the same type of consideration used by the Interested Person to acquire the
largest number of shares of such class previously acquired by the Interested
Person, and that the value of the consideration must be at least equal to the
highest of (i) the highest price paid by the Interested Person within 18 months
before the date of announcement of the proposed Business Combination (the
"Announcement Date") or in the transaction or series of transactions in which
such person became an Interested Person, (ii) the higher of the Fair Market
Value per share of such class on the Announcement Date or the date on which such
person became an Interested Person and (iii) if applicable, the redemption price
per share of such class or the amount per share such class is entitled to
receive upon liquidation of the Company. The Fair Price Requirements are further
conditioned on approval by the affirmative vote of the holders of a majority of
the Disinterested Shares (as defined in the Articles).
The Articles provide that the provisions of the Articles (i) requiring super
majority approval of Business Combinations involving Interested Persons, (ii)
defining the number of directors of the Company and the classification, election
and removal thereof, (iii) eliminating cumulative voting and preemptive rights,
(iv) providing for indemnification and limitation of liability of directors and
officers, (v) establishing procedures for calling special meetings of
shareholders and for handling shareholder proposals and (vi) establishing the
Company's authorized capital stock, may not be amended without approval (a) by a
majority of the authorized number of directors and, if an Interested Person
exists, by a majority of Continuing Directors or (b) by holders of at least
66 2/3% of the Company's outstanding voting stock.
The foregoing provisions of the Articles as well as the staggered terms for
directors and the availability of Preferred Stock for issuance without
shareholder approval may deter any potential unfriendly offers or other efforts
to obtain control of the Company that are not approved by the Board of Directors
and could thereby deprive the shareholders of opportunities to realize a premium
on their Common Stock and could make removal of incumbent management more
difficult. On the other hand, these provisions may induce any persons seeking
control of the Company or a business combination with the Company to negotiate
terms acceptable to the Board of Directors.
Washington law contains certain provisions that may have the effect of
delaying or discouraging a hostile takeover of the Company. Chapter 23B.19 of
the Washington Business Corporation Act prohibits a "Target Corporation" (as
defined in the Act), with certain exceptions, from engaging in certain
significant business transactions with an "Acquiring Person" (defined generally
as a person who acquires 10% or more of the corporation's voting securities
without the prior approval of the corporation's board of directors) for a period
of five years after such acquisition. The prohibited transactions include, among
others, a merger or share exchange with, disposition of assets to, or issuance
or redemption of stock to or from, the Acquiring Person, or a reclassification
of securities that has the effect of increasing the proportionate share of the
outstanding securities held by the Acquiring Person. An Acquiring Person may
avoid the prohibition against effecting certain significant business
transactions with the Target Corporation if the per share consideration paid to
holders of outstanding shares of common stock and other classes of stock of the
Target Corporation meets certain minimum criteria or if the board of directors
of the Target Corporation, at the time of the share acquisition, approves the
proposed significant business transaction. These provisions may have the effect
of delaying, deterring or preventing a change in control of the Company.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock of the Company is
ChaseMellon Shareholder Services.
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PLAN OF DISTRIBUTION
GENERAL
QFC may sell the Securities being offered hereby: (i) directly to
purchasers, (ii) through agents, (iii) through underwriters, (iv) through
dealers or (v) through a combination of any such methods of sale.
The distribution of the Securities may be effected from time to time in one
or more transactions either (i) at a fixed price or prices, which may be
changed; (ii) at market prices prevailing at the time of sale; (iii) at prices
related to such prevailing market prices; or (iv) at negotiated prices.
Offers to purchase Securities may be solicited directly by QFC or by agents
designated by QFC from time to time. Any such agent, which may be deemed to be
an underwriter, as such term is defined in the Securities Act, involved in the
offer or sale of the Securities in respect of which this Prospectus is delivered
will be named, and any commissions payable by QFC to such agent will be set
forth, in the Prospectus Supplement. Unless otherwise indicated in the
Prospectus Supplement, any such agent will be acting on a best efforts basis for
the period of its appointment. Agents may engage in transactions with, or
perform services for, QFC and/or certain affiliates thereof in the ordinary
course of business. An agent may resell a Security purchased by it as principal
to another broker-dealer at a discount.
If an underwriter or underwriters are utilized in the sale, QFC will execute
an underwriting agreement with such underwriters and the names of the
underwriters and the terms of the transaction will be set forth in the
Prospectus Supplement which will be used by the underwriters to make resales of
the Securities.
Except as otherwise indicated in the applicable Prospectus Supplement, if a
dealer is utilized in the sale of the Securities in respect of which this
Prospectus is delivered, QFC will sell such Securities to the dealer, as
principal. The dealer may then resell such Securities to the public at varying
prices to be determined by such dealer at the time of resale.
Underwriters, dealers, agents and other persons may be entitled, under
agreements which may be entered into with QFC, to indemnification against, or
contribution with respect to, certain civil liabilities under the Securities
Act.
Each underwriter, dealer and agent participating in the distribution of any
Securities that are issuable as Bearer Securities will agree that it will not
offer, sell or deliver, directly or indirectly, Bearer Securities in the United
States or to United States persons (other than qualifying financial
institutions) in connection with the original issuance of such Debt Securities.
DELAYED DELIVERY ARRANGEMENTS
If so indicated in the Prospectus Supplement, QFC may authorize agents and
underwriters to solicit offers by certain institutions to purchase Securities
from QFC at the public offering price set forth in the Prospectus Supplement
pursuant to Delayed Delivery Contracts (the "Contracts") providing for payment
and delivery on the date stated in the Prospectus Supplement. Each Contract will
be for an amount not less than, and unless QFC otherwise agrees, the aggregate
principal amount of Securities sold pursuant to Contracts shall be not less nor
more than, the respective amounts stated in the Prospectus Supplement.
Institutions with whom Contracts, when authorized, may be made include
commercial and savings banks, insurance companies, pension funds, investment
companies, educational and charitable institutions and other institutions, but
shall in all cases be subject to the approval of QFC. Contracts will be not
subject to any conditions except that the purchase by an institution of the
Securities covered by its Contract shall not at the time of delivery be
prohibited under the laws of any jurisdiction in the United States to which such
institution is subject. A commission indicated in the Prospectus Supplement will
be paid to underwriters and agents soliciting purchases of Securities pursuant
to Contracts accepted by QFC.
The place and time of delivery for the Securities in respect of which this
Prospectus is delivered are set forth in the accompanying Prospectus Supplement.
22
<PAGE>
EXPERTS
The financial statements of QFC incorporated by reference in QFC's Annual
Report on Form 10-K for the year ended December 30, 1995 have been audited by
Deloitte & Touche LLP, independent auditors, as stated in their report which is
incorporated herein by reference, and such financial statements are incorporated
by reference herein in reliance upon the report of Deloitte & Touche LLP given
upon the authority of that firm as experts in accounting and auditing.
The financial statements of Hughes Markets, Inc. incorporated by reference
in this Prospectus have been audited by Arthur Andersen LLP, independent public
accountants, as indicated in their report with respect thereto, and are
incorporated by reference herein in reliance upon the authority of said firm as
experts in giving said report.
LEGAL MATTERS
The legality of the Securities to be offered hereby will be passed upon for
QFC by Simpson Thacher & Bartlett (a partnership which includes professional
corporations), New York, New York, in respect of New York law, and by Bogle &
Gates P.L.L.C., Seattle, Washington, in respect of Washington law.
23
<PAGE>
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NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED OR
INCORPORATED BY REFERENCE IN THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS IN
CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. NEITHER THE
DELIVERY OF THIS PROSPECTUS SUPPLEMENT OR THE PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCE, CREATE AN IMPLICATION THAT THERE HAS
BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF. THIS
PROSPECTUS SUPPLEMENT AND THE PROSPECTUS DO NOT CONSTITUTE AN OFFER OR
SOLICITATION BY ANYONE IN ANY STATE OR OTHER JURISDICTION IN WHICH SUCH OFFER OR
SOLICITATION IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO OR TO ANYONE TO WHOM IT IS UNLAWFUL TO
MAKE SUCH OFFER OR SOLICITATION.
--------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
PROSPECTUS SUPPLEMENT
Available Information.......................... S-3
Incorporation of Documents by Reference........ S-3
Summary........................................ S-5
Risk Factors................................... S-19
Price Range of Common Stock and Dividend
Policy........................................ S-26
The Acquisitions............................... S-27
The Proposed Reorganization.................... S-30
Use of Proceeds................................ S-32
Capitalization................................. S-33
Unaudited Pro Forma Condensed Consolidated
Financial Statements.......................... S-34
Selected Historical Financial Data............. S-44
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.................................... S-48
Business....................................... S-62
Management..................................... S-80
Principal Shareholders......................... S-83
Description of Certain Indebtedness............ S-85
Description of Capital Stock................... S-90
Shares Eligible For Future Sale................ S-92
Certain U.S. Tax Consequences to Non-U.S.
Holders....................................... S-93
Underwriting................................... S-95
Legal Matters.................................. S-98
Experts........................................ S-98
Index to Financial Statements.................. F-1
<CAPTION>
PROSPECTUS
<S> <C>
Available Information.......................... 2
Incorporation of Documents by Reference........ 2
The Company.................................... 3
The Acquisitions............................... 3
Ratio of Earnings to Fixed Charges............. 5
Use of Proceeds................................ 5
Description of Debt Securities................. 5
Description of Preferred Stock................. 17
Description of Common Stock.................... 20
Plan of Distribution........................... 22
Experts........................................ 23
Legal Matters.................................. 23
</TABLE>
4,500,000 SHARES
[LOGO]
[LOGO]
QUALITY FOOD CENTERS, INC.
COMMON STOCK
----------------------
PROSPECTUS SUPPLEMENT
----------------------------
MERRILL LYNCH INTERNATIONAL
DONALDSON LUFKIN & JENRETTE
SECURITIES CORPORATION
SALOMON BROTHERS INTERNATIONAL
LIMITED
DAIN BOSWORTH
Incorporated
CREDIT LYONNAIS SECURITIES
DRESDNER KLEINWORT BENSON
PARIBAS
UBS LIMITED
MARCH 13, 1997
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