25
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Seaway Food Town, Inc.
We have audited the accompanying consolidated balance sheets of Seaway Food
Town, Inc. as of August 28, 1999, and August 28, 1998, and the related
consolidated statements of income, shareholders' equity, and cash flows for each
of the three years in the period ended August 28, 1999. 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 consolidated financial position of Seaway Food Town,
Inc. at August 28, 1999 and August 29, 1998, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
August 28, 1999 in conformity with generally accepted accounting principles.
/s/Ernst & Young LLP
October 15, 1999
Toledo, Ohio
<PAGE> 17
26
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED AUGUST 28, 1999, AUGUST 29, 1998, AND AUGUST 30, 1997
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
(52 weeks) (52 weeks) (52 weeks)
<S> <C> <C> <C>
Net sales $658,929 $625,178 $608,373
Cost of merchandise sold 490,952 465,797 455,631
------------- ---------------- ------------------
Gross profit 167,977 159,381 152,742
Selling, general and administrative
expenses 153,691 144,671 138,890
------------- ---------------- ------------------
Operating profit 14,286 14,710 13,852
Interest expense - net (3,951) (3,835) (3,760)
Other income - net 323 167 509
------------- ---------------- ------------------
Income before income taxes 10,658 11,042 10,601
Provision for income taxes 3,184 4,058 4,189
------------- ---------------- ------------------
Net income $ 7,474 $ 6,984 $ 6,412
============= ================ ==================
Net income per common share - basic and diluted
$ 1.12 $ 1.05 $ .97
============= ================ ==================
</TABLE>
See accompanying notes
<PAGE> 18
27
CONSOLIDATED BALANCE SHEETS
AUGUST 28, 1999 AND AUGUST 29, 1998
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 9,757 $ 8,968
Income tax recoverable -- 100
Notes and accounts receivable, less
allowance of $500 ($450 in 1998) for
doubtful accounts 9,717 7,674
Merchandise inventories 56,343 50,293
Prepaid expenses 1,353 1,518
Deferred income taxes 2,205 2,404
--------- ---------
Total current assets 79,375 70,957
Other assets, less accumulated amortization 6,167 3,731
of $4,274 ($4,006 in 1998)
Property and equipment, at cost
Land 7,900 7,903
Buildings and improvements 79,115 75,019
Leasehold improvements 32,771 31,077
Equipment 113,406 106,629
--------- ---------
233,192 220,628
Less accumulated depreciation and
amortization 137,920 126,653
-------- ---------
Net property and equipment 95,272 93,975
--------- ---------
$180,814 $168,663
======== ========
</TABLE>
<PAGE> 19
28
CONSOLIDATED BALANCE SHEETS
AUGUST 28, 1999 AND AUGUST 29, 1998
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable $46,658 $43,402
Income taxes 684 31
Accrued liabilities:
Insurance 3,344 3,374
Payroll 3,976 3,195
Taxes, other than income 2,760 2,613
Other 4,224 3,387
--------------- -------------
14,304 12,569
Long-term debt due within one year 1,043 1,393
--------------- -------------
Total current liabilities 62,689 57,395
Long-term debt 49,249 47,966
Deferred income taxes 1,343 2,474
Deferred other 3,499 3,475
Shareholders' equity
Serial preferred stock, without par value:
300,000 shares authorized, none issued -- --
Common stock, without par value (stated value
$2 per share): 24,000,000 shares authorized,
6,673,643 shares outstanding (6,648,928 in
1998) 13,347 13,298
Capital in excess of stated value 358 --
Retained earnings 50,329 44,055
--------------- -------------
Total shareholders' equity 64,034 57,353
--------------- -------------
$180,814 $168,663
=============== =============
</TABLE>
See accompanying notes
<PAGE> 20
29
CONSOLIDATED STATEMENTS OF CASH FLOW
YEARS ENDED AUGUST 28, 1999, AUGUST 29, 1998, and AUGUST 30, 1997
(Dollars in thousands)
<TABLE>
<CAPTION>
1999 1998 1997
(52 weeks) (52 weeks) (52 weeks)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 7,474 $ 6,984 $ 6,412
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 15,395 14,986 14,441
Stock contribution to benefit plan 407 255 401
Deferred income taxes (932) (101) (565)
Equity in income of affiliates (8) (3) (24)
Gain on disposal of property
and equipment (24) (484) (10)
Changes in assets and liabilities
affecting operations:
Notes and accounts receivable (2,043) (1,179) (582)
Merchandise inventories (6,050) (1,701) (3,518)
Prepaid expenses 165 (93) (84)
Accounts payable
and accrued liabilities 4,798 (928) (729)
Income taxes 753 (1,004) (589)
----------------- ----------------- ------------------
Net cash provided by operating activities 19,935 16,732 15,153
Cash flows from investing activities:
Expenditures for property
and equipment (14,912) (18,455) (19,537)
Proceeds from sale of property and equipment 196 623 416
Cash paid to acquire businesses (4,869) --- (2,134)
Other 489 1,103 1,071
----------------- ----------------- ------------------
Net cash used in investing activities (19,096) (16,729) (20,184)
Cash flows from financing activities:
Proceeds from issuance of long-term debt 10,900 7,800 40,300
Payments of long-term debt (9,967) (5,965) (38,605)
Payments for acquisitions of common shares --- --- (77)
Dividends paid (1,200) (1,062) (1,013)
Increase (decrease) in deferred other 217 (1,299) 4,151
----------------- ----------------- ------------------
Net cash provided by (used in) financing
activities (50) (526) 4,756
----------------- ----------------- ------------------
Increase (decrease) in cash and cash equivalents 789 (523) (275)
Cash and cash equivalents at
beginning of year 8,968 9,491 9,766
----------------- ----------------- ------------------
Cash and cash equivalents at end of year $ 9,757 $ 8,968 $ 9,491
================= ================= ==================
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 3,886 $ 2,931 $ 3,779
Income taxes 3,364 5,144 5,343
Noncash investing activities:
During fiscal 1998, the Company exchanged real estate with a basis of $1,367,844
</TABLE>
See accompanying notes
<PAGE> 21
30
SEAWAY FOOD TOWN, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED AUGUST 28, 1999, AUGUST 29, 1998, and AUGUST 30, 1997
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------------
Capital in Total
Excess of Share-
Common Stock Stated Retained Holders'
Shares Amount Value Earnings Equity
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at August 31, 1996 2,198,609 $4,397 $1,017 $40,039 $45,453
Net income (52 weeks) 6,412 6,412
Purchase of common shares for treasury (3,743) (7) (5) (65) (77)
Issuance of common shares 14,718 29 372 401
Effect of stock split 2,209,584 4,419 (1,384) (3,035) --
Dividends paid-$.15 per share (1,013) (1,013)
------------- ----------- --------------- ------------- -----------------
Balance at August 30, 1997 4,419,168 8,838 0 42,338 51,176
Net income (52 weeks) 6,984 6,984
Effect of stock split 2,216,301 4,433 (228) (4,205) --
Issuance of common shares 13,459 27 228 255
Dividends paid-$.16 per share (1,062) (1,062)
------------- ----------- --------------- ------------- -----------------
Balance at August 29, 1998 6,648,928 13,298 0 44,055 57,353
-----------------------------------------------------------------------------------------------------------------------------
Net income (52 weeks) 7,474 7,474
Issuance of common shares 24,715 49 358 407
Dividends paid-$.18 per share (1,200) (1,200)
------------- ----------- --------------- ------------- -----------------
Balance at August 28, 1999 6,673,643 $13,347 $358 $50,329 $64,034
-----------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes
<PAGE> 22
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Seaway Food Town, Inc.
1. SIGNIFICANT ACCOUNTING POLICIES
BUSINESS -- Seaway Food Town, Inc. (the Company) and its consolidated
subsidiaries operates in one business segment. Its business consists of the
sale and distribution of food, drugs, and related products, to retail
customers principally through 47 supermarkets and 26 drugstores. Principal
markets include northwest and central Ohio and southeast Michigan.
BASIS OF PRESENTATION -- The consolidated financial statements include the
accounts of Seaway Food Town, Inc. and all wholly-owned subsidiaries. All
amounts in the consolidated financial statements referring to shares, share
prices and per share amount have been adjusted retroactively for the May,
1998 three-for-two stock split and for the May, 1997 two- for-one stock
split.
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 amounts reported in the financial
statements and accompanying notes. Actual results could differ from these
estimates.
CASH AND CASH EQUIVALENTS -- The Company considers all highly liquid
investments with a maturity of three months or less when purchased to be
cash equivalents. The carrying amount reported in the balance sheets for
cash equivalents approximates its fair value.
INVENTORIES -- Meat, produce, bakery and deli are valued at the lower of
cost, using the first-in, first-out (FIFO) method, or market. Approximately
85% of the Company's inventories are valued at the lower of cost, using the
last-in, first-out (LIFO) method, or market. Inventories have been reduced
by $18,122,000 and $18,325,000 at August 28, 1999 and August 29, 1998,
respectively, from amounts which would have been reported under the FIFO
method (which approximates current cost).
IMPAIRMENT OF LONG-LIVED ASSETS - The carrying value of long-lived and
intangible assets is reviewed quarterly to determine if facts and
circumstances suggest that the assets may be impaired or that the
amortization period may need to be changed. The Company considers external
factors relating to each asset including local market developments. If
these external factors and the projected undiscounted cash flows over the
remaining amortization period indicate that the asset will not be
recoverable, the carrying value will be adjusted to the estimated fair
value. As of August 28, 1999 the Company does not believe there is any
indication that the carrying value or the amortization period of its assets
needs to be adjusted.
DEPRECIATION AND AMORTIZATION -- Depreciation and amortization are provided
principally under the straight-line method at rates based upon the
estimated useful lives of the various classes of assets. Capital leases not
involving a purchase of the assets are amortized over the lease term.
ADVERTISING -- The Company expenses the costs of advertising as incurred.
Advertising expense was $5,140,000 in 1999, $5,054,000 in 1998 and
$4,689,000 in 1997. Advertising expenses have been included in cost of
merchandise sold.
PENSIONS -- The Company contributes to pension plans covering substantially
all employees. Pension costs include defined contributions based upon wages
and specified amount per hour as required under collective bargaining
agreements. The Company's policy is to fund pension costs annually in the
amount accrued.
DEFERRED INCOME TAXES -- Deferred income taxes are provided on the asset
and liability method for all significant temporary differences between
income reported for financial statement purposes and taxable income.
NET INCOME PER COMMON SHARE -- Net income per common share is based upon
the weighted average number of common shares outstanding of 6,665,224 in
1999, 6,642,112 in 1998 and 6,615,470 in 1997. The Company has no
potentially dilutive securities.
NEW ACCOUNTING STANDARD - Financial Accounting Standards Board Statement,
No. 133 -- "Accounting for Derivative Instruments and Hedging Activities,"
will be applicable for fiscal 2001. This statement requires all derivatives
to be recorded on the balance sheet at fair value. The Company currently
expects the statement to have no effect because the Company has no
derivatives.
2. STORE ACQUISITIONS
The Company acquired two supermarkets in Ohio for $4,869,000 in fiscal 1999
and two supermarkets in Michigan for $2,134,000 in fiscal 1997. These
acquisitions were accounted for under the purchase method of accounting.
The resulting goodwill is being amortized over 20 years. The results of
operations for these stores are included in the accompanying statements of
income for the period after the effective date of the acquisitions.
<PAGE> 23
32
3. NOTES PAYABLE AND LONG-TERM DEBT
Long-term debt at August 28, 1999 and
August 29, 1998 consisted of the following (in thousands):
1999 1998
---- ----
7.42% to 9.22% senior
notes payable to insurance
companies, due through 2013 $33,000 $33,000
Revolving credit loan agree-
ments with banks, interest
of 5.98% to 7.50% 10,600 8,300
6.28% to 7.25% mortgage
notes payable, payments
due annually to 2008 4,695 4,997
Long-term lease obligations, 7.25%
to 13%, payments due in varying
monthly amounts through 2004.
(see Note 6). 1,950 2,938
Other notes payable 47 124
--------- ---------
50,292 49,359
Less amount due within one
year 1,043 1,393
--------- ---------
$49,249 $47,966
========= =========
At August 28, 1999, the Company had a revolving credit agreement permitting
borrowings up to $45,000,000 in the aggregate ($15,000,000 per bank) due
October 1, 2001. Interest is charged, at the Company's option, at the
current prime rate, swing line rate, or a certain percentage point in
excess of the current LIBOR rate based on a ratio of total liabilities to
tangible net worth. The Company is required to pay a fee of .20% to .25% on
any unused portion of the loan commitment. The Company had borrowings of
$10,600,000 under this agreement at August 28, 1999.
The Company has two senior note agreements which provide for repurchases of
notes, at either the Company's or holder's option, in amounts not in excess
of $8,000,000 in 2000, $12,000 000 in 2005 and $13,000,000 in 2008. In
addition, the agreements allow for prepayments, at the Company's option,
subject to certain prepayment provisions. The Company issued $25,000,000 of
these senior notes to an insurance company in August, 1997. The Company has
exercised its option to prepay the $8,000,000 of senior notes with an
interest rate of 9.10% and 9.22%. The notes will be paid in December, 1999
with amounts available under the revolving credit loan agreements resulting
in a long-term classification at August 28, 1999.
The senior notes and revolving credit loan agreements referred to above
include certain working capital, net worth and debt service covenants along
with restrictions on the payment of cash dividends. The restriction of
dividends is based on a percentage of the excess of income available for
debt service.
At August 28, 1999, the approximate undepreciated cost of property and
equipment subject to mortgages was $10,100,000.
Annual maturities of long-term debt other than revolving credit amounts for
each of the five fiscal years subsequent to August 28, 1999 are as follows:
2000 - $1,043,000; 2001 - $883,000; 2002 - $714,000; 2003 - $699,000 and
2004 - $579,000.
At August 28, 1999, the carrying value of the long-term debt in aggregate,
excluding capitalized lease obligations, approximates its fair value. The
fair value is estimated using discounted cash flow analyses, based on the
Company's current incremental borrowing rates.
<PAGE> 24
33
4. INCOME TAXES
The provision (credit) for income taxes consists of the following (in
thousands):
1999 1998 1997
---- ---- ----
Current:
Federal $3,557 $3,562 $4,115
State and local 559 597 639
--------- -------- ---------
4,116 4,159 4,754
Deferred:
Federal (767) (72) (483)
State and local (165) (29) (82)
-------- -------- --------
(932) (101) (565)
-------- -------- --------
$3,184 $4,058 $4,189
======== ======== ========
The consolidated effective tax rate differs from the statutory U.S. Federal
tax rate for the following reasons and by the following percentages:
1999 1998 1997
---- ---- ----
Statutory U.S. Federal
tax rate 34.2% 34.0% 34.2%
Increase (reduction) in
taxes resulting from:
State and local income
taxes net of the
related reduction
in federal
income taxes 2.4 3.4 3.5
Adjustments to estim-
ated income tax
accruals (5.8) -- --
Other (.9) (.8) 1.8
------- ------- -------
Effective tax rate 29.9% 36.8% 39.5%
======= ======= =======
Significant components of the Company's deferred income tax assets and
liabilities as of August 28, 1999 and August 29, 1998 are as follows (in
thousands):
1999 1998
---- ----
Deferred income tax assets:
Accrued expenses $2,290 $2,253
Expenses inventoried for tax purposes 1,008 950
Other 345 419
------- -------
$3,643 $3,622
======= =======
Deferred income tax liabilities:
Excess tax depreciation $1,528 $2,500
Deferred project costs 127 393
Other 1,126 799
------ -------
$2,781 $3,692
======= =======
The above are reflected in the balance sheets as of August 28, 1999 and
August 29, 1998 as follows (in thousands):
1999 1998
---- ----
Current deferred income tax asset $2,205 $2,404
====== =======
Noncurrent deferred income tax liability $1,343 $2,474
====== =======
<PAGE> 25
34
5. EMPLOYEE BENEFIT PLANS
Effective January 1, 1998, the Company merged its Employee Stock Ownership
Plan into the 401(k) plan. Employee contributions to the 401(k) plan
consist of salary deferrals of up to 15%, not to exceed the maximum annual
allowable amount for income tax purposes. The Company matches 50% of
employee salary deferral contributions up to 6% of an employee's
compensation, and contributes Company common stock in an amount not less
than 2 1/2% of each eligible employee's total annual compensation. The
Company's expense was $1,281,000 in 1999, $1,115,000 in 1998, and
$1,007,000 in 1997.
In 1999, the Company adopted a Supplemental Executive Retirement Plan
(SERP) for its highly compensated employees. Under the SERP, the Company
will fund the amounts above the qualified IRS limits into a nonqualified
plan. The Company's expense was $3,000 in 1999.
In addition, the Company contributes to several area-wide defined benefit
union pension plans established under collective bargaining agreements. The
aggregate costs for these plans amounted to $2,582,000 in 1999, $2,571,000
in 1998, and $2,313,000 in 1997. Under the Multi-employer Pension Plan
Amendments Act of 1980, the Company could become liable for its
proportionate share of unfunded vested benefits, if any, in the event of
the termination of, or its withdrawal or partial withdrawal from, the
union-sponsored plans to which the Company makes contributions.
6. LEASE COMMITMENTS
Capital leases
The cost and accumulated amortization of property leased under long-term
noncancellable leases are as follows (in thousands):
1999 1998
---- ----
Land $ 56 $ 56
Buildings 6,519 6,523
Equipment 78 2,509
---------- ----------
6,653 9,088
Less accumulated
amortization 5,383 6,633
---------- ----------
$ 1,270 $ 2,455
========== ==========
Future minimum lease payments under capital leases together with the
present value of net minimum lease payments as of August 28, 1999 are as
follows (in thousands):
2000 $800
2001 599
2002 372
2003 307
2004 179
Later years 0
-------
Total minimum lease payments 2,257
Less amount representing interest 307
-------
Present value of net minimum lease
payments (included in long-term
debt at August 28, 1999 -- see
Note 2) $1,950
=======
OPERATING LEASES
Minimum annual rentals for facilities and equipment leased under operating
leases aggregate approximately $40,081,000 payable as follows (in
thousands):
Facilities Equipment
---------- ---------
2000 $ 6,764 $234
2001 6,260 140
2002 5,829 86
2003 4,826 86
2004 3,566 86
Later years 12,178 26
-------- --------
$39,423 $658
======== ========
<PAGE> 26
35
The leases expire at various dates from 2000 to 2012 and substantially all
are renewable for one or more successive five year periods, in some cases
at slightly higher rentals.
Total rent expense attributable to operating leases amounted to
approximately $7,108,000 in 1999, $6,735,000 in 1998, and $6,285,000 in
1997 and included provisions for additional rentals of $193,000 in 1999,
$171,000 in 1998, and $227,000 in 1997 based upon gross sales in excess of
specified amounts.
7. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarterly financial data for the years ended August 28, 1999, and August
29, 1998 are presented below (in thousands of dollars except per share
amounts):
First Second Third Fourth
----- ------ ----- ------
Net sales:
1999 $156,630 $170,382 $167,306 $164,611
1998 153,952 159,935 154,557 156,734
Gross profit:
1999 39,743 42,821 42,748 42,665
1998 39,288 40,798 39,645 39,650
Net income:
1999 1,421 2,324 1,863 1,866 (1)
1998 1,371 2,095 1,698 1,820
Net income per
common share -
basic and diluted:
1999 .21 .35 .28 .28 (1)
1998 .21 .31 .26 .27
(1) The fiscal 1999 fourth quarter was favorably impacted by an adjustment
to estimated income tax accruals resulting in increases in net income
of $513,000 and net income per share of $.08.
