ITEM 1 - BUSINESS
Unless we state otherwise or the context otherwise requires, the terms “we,” “us,” “our,” “Roundy’s,” “the Company,” “our business,” “our company” refer to Roundy’s, Inc. and its subsidiaries as a combined entity.
We are a leading Midwest supermarket founded in 1872 as a privately owned food wholesaling company. In 1952, we were sold to certain of our customers and until 2002 operated under the Roundy’s corporate name as a retailer owned cooperative, with food wholesaling operations largely focused in Wisconsin. We opened our first Pick ’n Save store in 1975 and built a base of company-owned and operated retail stores throughout the 1980s and 1990s.
In June 2002, we were acquired by an investor group led by Willis Stein and our management team. At that time, we derived more than 50% of our sales from food wholesaling operations and the remainder from our company-operated retail stores. Following the acquisition, we accelerated our strategy of expanding our retail store base through selective acquisitions and organic growth, while divesting our wholesale operations. The substantial elimination of the wholesale business has helped to optimize our distribution network to better support our retail stores. As of January 3, 2015, our retail operations consisted of 148 grocery stores, with 119 stores in Wisconsin operating under the Pick ’n Save, Copps and Metro Market banners and 29 stores in Illinois operating under the Mariano’s banner.
Our corporate headquarters are located at 875 East Wisconsin Avenue, Milwaukee, Wisconsin 53202. Our telephone number is (414) 231-5000. Our website address is www.roundys.com.
Stores
We operate retail grocery stores under our Pick ’n Save, Mariano’s, Copps and Metro Market retail banners. The following table represents our store network as of the end of each of our last five fiscal years:
Our stores, which average approximately 63,000 square feet, offer all of the products and services found in a conventional supermarket, including nationally branded food products and own-brand products. In addition, our stores feature expansive meat, produce, deli and other perishable products and specialty and prepared foods departments, which represent higher growth and margin categories. We also offer a broad line of health and beauty care products and a large selection of seasonal merchandise to maximize the conveniences offered to our customers. Substantially all stores have full-service deli, meat, seafood and bakery departments, and 97 stores feature full-service pharmacies.
Our Pick ’n Save and Copps retail banners are operated as high volume, value oriented supermarkets that seek to offer attractive prices and the best value among conventional food retailers in a given market. Our value price strategy is complemented by weekly promotions, a broad assortment of high quality fresh produce and other perishable products, as well as a focus on providing a high level of customer service and conveniences.
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Pick ’n Save. We operate Pick ’n Save stores primarily in the Milwaukee area, as well as in certain other Wisconsin markets, including Racine, Oshkosh, Kenosha, and Fond du Lac. We also serve as the primary wholesaler for one additional Pick ’n Save bannered store that we do not operate.
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Copps. We operate Copps stores primarily in the Madison area as well as in certain northern Wisconsin markets, including Green Bay and Appleton.
We have focused on leveraging our strong brand names, high level of customer service, high quality perishables and strategically located stores, to increase market share. We believe the Pick ’n Save banner maintains the number one market share position in the Milwaukee metropolitan area. Additionally, through the Pick ’n Save and Copps banners, we believe we also maintain the number one market share position in several other large Wisconsin markets, including Madison, Racine and Oshkosh.
Our Mariano’s and Metro Market specialty food retail banners combine our value oriented conventional offering with an enhanced selection of full-service premium perishable and prepared food departments.
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Mariano’s. We entered the Chicago market in July 2010 through the opening of our first Mariano’s store in Arlington Heights, Illinois. As of January 3, 2015, we had opened 29 stores in the Chicago market and secured 10 leases for future stores in attractive locations. During Fiscal 2014, we continued our expansion in Chicago by opening a total of 16 stores, including 11 former Dominick’s stores that were acquired from Safeway in December 2013. Mariano’s brings an innovative format to the Chicago market, with its expanded variety of produce and other perishables, unique specialty departments and superior customer service within an inviting ambiance.
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Metro Market. We opened our first Metro Market store in August 2004 primarily to serve downtown Milwaukee apartment and condominium residents. The Metro Market store format features an expanded variety of produce, meat and prepared food offerings, coupled with exceptional customer service. We opened our second Metro Market store in March 2010 and our third in February 2011. Both of these additional locations are in suburbs of Milwaukee. We opened our fourth Metro Market in June 2014 in Madison, Wisconsin. All Metro Market stores operate in-store pharmacies.
Merchandising
We provide our customers with a compelling one-stop shopping experience featuring a high level of customer service in our attractive and convenient stores. Our product assortment includes high quality perishables and a broad selection of national brand and own-brand products at competitive prices. Many of our product categories include natural and organic options, catering to our customers’ focus on healthier eating choices.
Products
We offer our customers a wide variety of products, with a typical store stocking approximately 45,000 different items. Our stores sell most nationally advertised brands, as well as numerous products under our Roundy’s own-brand labels, which maintain strong brand recognition throughout our markets. Our products can broadly be classified as non-perishable, perishable and non-food. Non-perishable food categories consist of grocery, frozen, and dairy products. Perishable categories include produce, meat, seafood, deli, bakery and floral. Non-food primarily includes general merchandise, health and beauty care, pharmacy, and alcohol.
In recent years, we have enhanced the quality and selection of key perishable products to meet growing customer demand due to an increased focus on healthy eating. Perishable product sales also typically generate higher gross margins than non-perishable products. As a result, the percentage of sales from continuing operations generated from perishable products has increased in recent periods as illustrated by the table below:
We generally classify our products into the following primary categories: grocery, frozen & dairy; produce; meat & seafood; bakery; deli, cheese & prepared foods; floral; general merchandise; alcohol; pharmacy; and health & beauty care. A brief description of the type of products we offer within each of these categories is set forth below.
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Grocery, Frozen & Dairy. We offer a wide selection of grocery items at competitive prices, including both national brands and own-brands. Our frozen department offers everyday staples such as vegetables, juice, microwaveable dinners, pizza and ice cream. Our dairy department offers milk, yogurt, sour cream, cheese and eggs. We also provide a broad selection of wheat free, gluten free, natural and organic products.
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Produce. We are committed to offering our customers the highest quality produce. We offer over 600 varieties of fresh fruit and vegetables sourced locally and from around the globe. Our stores offer an expansive assortment of USDA Certified organic produce. Our value-added produce offering includes fresh cut fruit, fresh squeezed juice and salad bars in many of our stores.
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Meat & Seafood. We offer a distinctive selection of meat and fresh seafood, including natural, organic and grass fed varieties, delivered with knowledgeable customer service. Our beef offerings consists primarily of fresh cut USDA Black Angus Choice graded beef, and we also sell all-natural pork, lamb, veal, Italian sausage and bratwurst, and Grade A chicken. Our fresh seafood includes, for example, salmon, whitefish and locally harvested rainbow trout. In addition, we offer popular oven ready-to-bake selections in our seafood department.
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Bakery. Our bakery department offers a wide selection of breads, rolls, pies, donuts, muffins, cookies, pastries and other goods baked in-store daily. Our Roundy’s Select muffins are made with high quality ingredients, including Maine wild blueberries, Wisconsin cranberries, and spicy Korintje cinnamon. Roundy’s breads range from traditional French and Italian loaves to select artisanal varieties.
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Deli, Cheese & Prepared Foods. We provide our customers with a “neighborhood deli” experience by offering fresh foods from high quality suppliers at competitive prices. Our deli selections include fresh salads, sandwiches, meals to go, and fresh sliced deli meats. We also offer an abundant selection of local, domestic, and imported artisanal cheeses, including creamy brie, gruyere, hard shaving cheeses, fresh mozzarella, and sharp cheddars. We also offer many varieties of fresh soups that are sold hot on our soup bars. Our prepared foods include entrees such as meat loaf, chicken Milanese, rotisserie chickens, baby back ribs, chicken pot pies, empanada’s, various varieties of quiche, and hand-breaded, fresh fried chicken.
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Floral. We are committed to providing our customers with the freshest roses, bouquets, arrangements, blooming and green plants and attractive seasonal favorites. Our fresh flower market offers a broad variety of cut flowers and allows customers to create their own bouquets.
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General Merchandise. In order to maximize the conveniences offered to our customers that facilitate one-stop shopping, we offer a wide variety of greeting cards, gift cards, candy and seasonal merchandise, as well as an assortment of household cleaning products, cooking utensils, some hardware/electrical items and batteries. We also offer a wide selection of baby products for our customers from diapers to baby food and formula.
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Alcohol. We offer a wide selection of competitively priced beer, wine and spirits. Our beer selection includes over 70 domestic and international brands in multiple styles, including local and regional craft beers. We also offer a wide assortment of wines from North America and around the world, and a broad variety of spirits.
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Pharmacy. Our pharmacies are full service pharmacies offering both clinical services as well as the more traditional dispensing functions. We accept a majority of commercial and Medicare Part-D plans in addition to State Medicaid and Medicare Part-B. All of our pharmacies have licensed immunizers on staff. We offer a broad array of immunization services both in store and within the communities we operate in.
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Health & Beauty Care. Our stores provide a convenient location for everyday health and beauty needs. We stock a wide variety of healthcare products, from thermometers and bandages to toothpaste and floss. We carry a variety of nationally branded cosmetic lines in addition to everyday beauty and haircare products.
Own-Brand Strategy
Roundy’s brands are rooted in a tradition of quality and superior value that our customers can trust. At the same time, Roundy’s products have kept pace with changing customer preferences and national brand innovation. Our brands include: Simply Roundy’s Organic-USDA certified organic, minimally processed and free from artificial additives and colors; Roundy’s Select-combining outstanding ingredients with exceptional quality; Roundy’s and Roundy’s Fresh-affordable, high quality products that are equal to or better than the leading national brands and Clear Value-offering a value price alternative to our competitors’ lowest price brands. We also offer solutions for our customers’ other shopping needs with our non-food lines, including Roundy’s Pet Care, Roundy’s Pharmacy and Top Care. Our portfolio of own-brand items includes approximately 7,100 items as of January 3, 2015, with a percentage of sales from own-brand items representing 24.5% of our net sales for the year ended January 3, 2015.
Competitive Environment
For the disclosure related to the Company’s competitive environment, see Item 1A
ITEM 1A - RISK FACTORS
There are risks and uncertainties that can affect our business, financial condition and results of operation, any one of which could cause our actual results to vary materially from recent results or from those indicated by forward looking statements included within this Annual Report on Form 10-K, and within other filings with the SEC,
news releases, registration statements and other written communication. Any of these risks could materially and adversely affect our business, financial condition and results of operations, which in turn could materially and adversely affect the price of our common stock.
Risks Related to our Business
We operate in a highly competitive industry.
The retail food industry as a whole, and our marketing areas in Wisconsin and Chicago, are highly competitive. We compete with various types of retailers, including national, regional and local conventional supermarkets, national and regional supercenters, membership warehouse clubs, and other alternative food retailers, such as natural foods stores, smaller specialty stores and farmers’ markets.
Our principal competitors include national conventional supermarkets such as New Albertson’s, Inc. (operating under the Jewel/Osco banner); national supercenters such as Costco, Target and Wal-Mart; regional supercenters such as Woodman’s and Meijer’s; regional supermarkets such as Festival Foods, Piggly Wiggly and Hy-Vee, Inc.; alternative food retailers such as Aldi, Trader Joe’s and Whole Foods; and local supermarkets, natural foods stores, smaller specialty stores and farmers’ markets. In general, we compete with Aldi, Costco, Target, Wal-Mart, Trader Joe’s and Whole Foods across all of our geographic markets. Our remaining principal competitors within each of our geographic markets vary to a significant degree and include the following:
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Wisconsin: Festival Foods, Piggly Wiggly, Woodman’s and Hy-Vee, Inc.;
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Chicago: Jewel/Osco, Meijer’s, and Strack & Van Til.
Some of these competitors have attempted to increase market share by expanding their footprints in our marketing areas. This competitor expansion creates a more difficult competitive environment for us. We also face limited competition from restaurants and fast-food chains. In addition, other established food retailers could enter our markets, increasing competition for market share.
We compete with other food retailers primarily on the basis of product selection and quality, price, customer service, store format and location or a combination of these factors. Pricing in particular is a significant driver of consumer choice in our industry and we regularly engage in price competition. To the extent that our competitors lower prices, our ability to maintain gross profit margins and sales levels may be negatively impacted. We expect competitors to continue to apply pricing and other competitive pressures. Some of our competitors have greater resources than we do and do not have unionized work forces, which may result in lower labor and benefit costs. These competitors could use these advantages to take measures, including reducing prices, which could materially adversely affect our competitive position, our financial condition and results of operations.
In addition to price competitiveness, our success depends on our ability to offer products that appeal to our customers’ preferences. Failure to offer such products, or to accurately forecast changing customer preferences, could lead to a decrease in the number of customer transactions at our stores and a decrease in the amount customers spend when they visit our stores. We also attempt to create a convenient and appealing shopping experience for our customers in terms of customer service, store format and location. If we do not succeed in offering attractively priced products that consumers want to buy or are unable to provide a convenient and appealing shopping experience, our sales, operating margins and market share may decrease, resulting in reduced profitability.
Economic conditions that impact consumer spending could materially affect our business.
Ongoing economic uncertainty continues to negatively affect consumer confidence and discretionary spending. Our results of operations may be materially affected by changes in economic conditions nationwide or in the regions in which we operate that impact consumer confidence and spending, including discretionary spending. This risk may be exacerbated if customers choose lower-cost alternatives to our product offerings in response to economic conditions. In particular, a decrease in discretionary spending could adversely impact sales of certain
of our higher margin product offerings. Future economic conditions affecting disposable consumer income, such as employment levels, business conditions, changes in housing market conditions, the availability of credit, interest rates, tax rates and fuel and energy costs, could reduce overall consumer spending or cause consumers to shift their spending to lower-priced competitors. In addition, inflation or deflation can impact our business. Food deflation could reduce sales growth and earnings, while food inflation, combined with reduced consumer spending, could reduce gross profit margins. As a result, our results of operations could be materially adversely affected.
The geographic concentration of our stores creates an exposure to local economies and regional downturns that may materially adversely affect our financial condition and results of operations.
As of January 3, 2015, we operated 119 stores in Wisconsin, making Wisconsin our largest market with 80% of our stores. Of our Wisconsin stores, 57, or approximately one-half, are located in the Milwaukee area. Our business is closely linked to local economic conditions in those areas and, as a result, we are vulnerable to economic downturns in those regions. In addition, any other factors that negatively affect these areas could materially adversely affect our revenues and profitability. These factors could include, among other things, changes in regional demographics, population and employer base. Any of these factors may disrupt our businesses and materially adversely affect our financial condition and results of operations.
We may be unable to maintain or improve levels of same-store sales, which could harm our business and cause our stock price to decline.
We may not be able to maintain or improve our current levels of same-store sales. Our same-store sales have fluctuated in the past and will likely fluctuate in the future. A variety of factors affect our same-store sales, including:
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overall economic trends and conditions;
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consumer preferences, buying trends and spending levels;
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our competition, including competitor store openings or closings near our stores;
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the pricing of our products, including the effects of inflation or deflation;
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the number of customer transactions in our stores;
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our ability to provide product offerings that generate new and repeat visits to our stores;
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the level of customer service that we provide in our stores;
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our in-store merchandising-related activities;
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our ability to source products efficiently; and
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the number of stores we open, remodel or relocate in any period.
Adverse changes in these factors may cause our same-store sales results to be materially lower than in recent periods, which would harm our business and could result in a decline in the price of our common stock.
We may be unable to maintain our operating margins.
We intend to maintain our operating margins in an environment of increased competition through various initiatives, including expansion of our own-brand offerings, increased sales of perishables and prepared foods, improved ordering, and strategic remodels and relocations of our stores, as well as continued cost discipline focused on improving labor productivity and reducing inventory shrink. If competitive pressures cause us to lower our prices, our operating margins may decrease. If customers do not adopt our increased own-brand, perishable or prepared food offerings, these higher margin items will not improve our operating margins. If we
do not adequately refine and improve our various ordering, tracking and allocation systems, we may not be able to increase sales and reduce inventory shrink. Any failure to achieve gains in labor productivity may adversely impact our operating margins. As a result, our operating margins may stagnate or decline.
Prolonged labor disputes with unionized employees and increases in labor costs could adversely affect us.
Our largest operating costs are attributable to labor costs and, therefore, our financial performance is greatly influenced by increases in wage and benefit costs, including pension and health care costs. As a result, we are exposed to risks associated with a competitive labor market and, more specifically, to any disruption of our unionized work force.
As of January 3, 2015, approximately 62% of our employees were represented by unions and covered by collective bargaining or similar agreements that are subject to periodic renegotiation. Our renegotiation of expiring collective bargaining agreements and negotiation of new collective bargaining agreements may not prove successful, may result in a significant increase in labor costs, or may result in a disruption to our operations. We expect that we would incur additional costs and face increased competition if we lost customers during a work stoppage or labor disturbance.
As of January 3, 2015, we had an aggregate of 43 collective bargaining agreements in effect, all of which are scheduled to expire between 2015 and 2019. As of January 3, 2015, there were no employees operating under an expired collective bargaining agreement.
In the renegotiation of our current contracts and the negotiation of our new contracts, rising health care and pension costs and the nature and structure of work rules will be important issues. The terms of the renegotiated collective bargaining agreements could create either a financial advantage or disadvantage for us as compared to our major competitors and could have a material adverse effect on our results of operations and financial condition. Our labor negotiations may not conclude successfully and work stoppages or labor disturbances could occur. A prolonged work stoppage affecting a substantial number of stores could have a material adverse effect on our financial condition, results of operations and cash flows. We also expect that in the event of a work stoppage or labor disturbance, we could incur additional costs and face increased competition for customers.
The Patient Protection and Affordable Care Act may materially increase our costs and/or make it harder for us to compete as an employer.
The Patient Protection and Affordable Care Act imposes new mandates on employers, including a requirement effective January 1, 2015 that employers with 50 or more full-time employees provide “credible” health insurance to employees or pay a financial penalty. Given our generally low-wage workforce and our current health plan design, and assuming the law is implemented without significant changes, these mandates could materially increase our costs. Moreover, if we choose to opt out of offering health insurance to our employees, we may become less attractive as an employer and it may be harder for us to compete for qualified employees.
We may not be able to successfully implement our expansion into the Chicago market, which could limit our prospects for future growth.
Our ability to continue to expand into the Chicago market with a new format of stores under our Mariano’s banner is an important component of our business strategy. Successful execution of this expansion depends upon, among other things:
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the levels of sales and profitability of Mariano’s stores;
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the hiring, training and retention of skilled store personnel and management;
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the incorporation of new Mariano’s stores into our existing distribution network;
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the negotiation of acceptable lease terms for store sites;
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the effective management of inventory to meet the needs of our stores on a timely basis;
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the availability of levels of cash flow or financing necessary to support our expansion; and
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our ability to successfully address competitive pricing, merchandising, distribution and other challenges encountered in connection with expansion into the Chicago market.
We, or our third-party vendors, may not be able to adapt our distribution, management information and other operating systems to adequately supply products to new stores at competitive prices so that we can operate the stores in a successful and profitable manner. Additionally, our expansion into the Chicago market will place increased demands on our operational, managerial and administrative resources. These increased demands could cause us to operate our existing business less effectively, which in turn could cause deterioration in the financial performance of our existing stores.
In addition, new stores build their sales volume and their customer base over time and, as a result, generally have lower gross margin rates and higher operating expenses, as a percentage of sales, than our more mature stores. If our Chicago market stores do not generate sufficient revenue or operate with acceptable margins, or if we experience an overall decline in performance, we may slow or discontinue our expansion plans, or we may decide to close stores in Chicago or elsewhere. We believe that the competitive dynamics in Chicago are currently favorable for our expansion into the market, but to the extent these conditions change, on account of competitors reacting to our entrance or otherwise, our growth may be inhibited. If we fail to successfully implement our expansion into Chicago, our growth prospects will be materially limited.
We may not realize all of the expected benefits from the Chicago Stores Acquisition.
We believe that the Chicago Stores Acquisition will enable us to increase our market share in the Chicago area and continue to grow a unique brand in that market. The Chicago Stores Acquisition is the first expansion of Mariano’s through the purchase of existing store locations, and represents the largest simultaneous expansion of Mariano’s store locations to date. Our ability to realize the anticipated benefits of the Chicago Stores Acquisition depends, to a large extent, on our ability to implement the Mariano’s store concept, support a larger number of stores with our existing supply chain operations and continue to provide a unique shopper experience. Our management will be required to devote significant attention and resources to these efforts, which may disrupt the operations at our existing stores and, if executed ineffectively, could preclude realization of the full benefits we expect. Failure to realize the anticipated benefits of this investment could cause an interruption of, or a loss of momentum in our operations. In addition, the efforts required to realize the benefits of this Chicago Stores Acquisition may result in material unanticipated problems, expenses, liabilities, competitive responses, loss of customer relationships, and the diversion of management’s attention, and may have a material adverse effect on our operating results.
Increased commodity prices and availability of commodities may impact our profitability.
Many of our products include ingredients such as wheat, corn, oils, milk, sugar, proteins, cocoa and other commodities. Commodity prices worldwide have generally been increasing. While commodity price inputs do not typically represent the substantial majority of our product costs, any increase in commodity prices may cause our vendors to seek price increases from us. Although we typically are able to mitigate or plan for vendor efforts to increase our costs, we may be unable to continue to do so, either in whole or in part. In the event we are unable to continue mitigating potential vendor price increases, we may in turn consider raising our prices, and our customers may be deterred by any such price increases. Our profitability may be impacted through increased costs to us which may impact gross margins, or through reduced revenue as a result of a decline in the number and average size of customer transactions.
Our plans to remodel or relocate certain of our existing stores and build new stores in the Chicago market require us to spend capital, which must be allocated among various projects. Failure to use our capital efficiently could have an adverse effect on our profitability.
We plan to remodel or relocate certain of our existing stores, and to open additional Mariano’s stores in the Chicago market. These initiatives will use cash generated by our operations. If this cash is not allocated efficiently among these various projects, or if any of these initiatives prove to be unsuccessful, we may experience reduced profitability and we could be required to delay, significantly curtail or eliminate planned store openings, remodels or relocations.
We have significant debt service and lease obligations and may incur additional indebtedness in the future which could adversely affect our financial health and our ability to react to changes to our business.
We have significant debt service and lease obligations, which could adversely affect our financial health. As of January 3, 2015, we had approximately $659.0 million in total debt and capital lease obligations, including capital lease obligations related to discontinued operations. In addition, we had future minimum lease payment commitments of approximately $2.4 billion at January 3, 2015.
Our high level of debt and fixed lease obligations will require us to use a significant portion of cash generated by our operations to satisfy these obligations, and could adversely impact our ability to obtain future financing to support our capital expenditures or other operational investments.
In Fiscal 2013, we had debt service repayments of $159.3 million and interest payments of $44.8 million. Fiscal 2013 debt service obligations included scheduled repayments on our senior credit facility, as well as an optional prepayment on our senior credit facility of $148.0 million.
In Fiscal 2014, we had debt service repayments of $76.4 million and interest payments of $54.8 million. Fiscal 2014 debt service obligations included scheduled repayments on our New Term Facility, as well as the net pay down of $56.9 million resulting from the 2014 Refinancing (as defined herein) and prepayment on our New Term Facility of $13.0 million with proceeds from the sale of our Stevens Point distribution facility.
If we cannot generate sufficient cash flow from operations to service our debt, we may need to refinance our debt, dispose of assets or issue equity to obtain necessary funds. We do not know whether we will be able to take any of such actions on a timely basis, on terms satisfactory to us or at all. Our level of indebtedness has important consequences. For example, our level of indebtedness may:
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require us to use a substantial portion of our cash flow from operations to pay interest and principal on our debt, which would reduce the funds available to us for working capital, capital expenditures and other general corporate purposes;
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limit our ability to obtain additional financing for working capital, capital expenditures, expansion plans and other investments, which may limit our ability to implement our business strategy;
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heighten our vulnerability to downturns in our business, the retail food industry or in the general economy and limit our flexibility in planning for, or reacting to, changes in our business and the retail food industry; or
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prevent us from taking advantage of business opportunities as they arise or successfully carrying out our plans to expand our store base and product offerings.
We cannot assure you that our business will generate sufficient cash flow from operations or that future financing will be available to us in amounts sufficient to enable us to make payments on our indebtedness or to fund our operations. In addition, our failure to make payments under our operating leases could trigger defaults under other leases or under agreements governing our other indebtedness, which could cause the counterparties under those agreements to accelerate the obligations due thereunder.
We will require substantial cash flows from operations to make our payments under our operating leases. If we are not able to make the required payments under our debt and lease agreements, the lenders or owners of the stores we lease may, among other things, repossess those assets, which could adversely affect our ability to conduct our operations.
While our existing credit facilities (the “2014 Credit Facilities) and the indenture governing the senior secured second lien notes due 2020 (the “2020 Notes”), restrict us and our subsidiaries from incurring additional debt, these restrictions include exceptions that will allow us and our subsidiaries to incur additional debt. If additional debt is issued, the risks described above could intensify.
The terms of our credit facilities agreement and indenture governing the notes may restrict our current and future operations, which could adversely affect our ability to respond to changes in our business and to manage our operations.
The 2014 Credit Facilities and the indenture governing the 2020 Notes include a number of customary restrictive covenants. These covenants could impair our financing and operational flexibility and make it difficult for us to react to market conditions and satisfy our ongoing capital needs and unanticipated cash requirements. Specifically, such covenants may restrict our ability and, if applicable, the ability of our subsidiaries to, among other things:
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incur additional debt;
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make certain investments;
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enter into certain types of transactions with affiliates;
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pay dividends or make other payments by our restricted subsidiaries to us;
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use assets as security in other transactions;
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pay dividends on our common stock or repurchase our equity interests;
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sell certain assets or merge with or into other companies;
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guarantee the debts of others;
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enter into new lines of business;
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make capital expenditures;
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prepay, redeem or exchange or debt; and
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form any joint ventures or subsidiary investments.
Our failure to comply with the restrictive covenants described above as well as the terms of any future indebtedness we may incur from time to time could result in an event of default, which, if not cured or waived by lenders, could result in our being required to repay those borrowings before their due date. If we are forced to refinance these borrowings on less favorable terms, our results of operations and financial condition could be adversely affected.
Proposed changes to financial accounting standards could require our store leases to be recognized on the balance sheet.
In addition to our significant level of indebtedness, we have significant obligations relating to our current operating leases. Proposed changes to financial accounting standards could require such leases to be recognized on the balance sheet. As of January 3, 2015, we had undiscounted operating lease commitments of approximately $2.4 billion, scheduled through 2035, related primarily to our stores. These leases are classified as operating leases and disclosed in Note 13 to our audited consolidated financial statements set forth in Item 8 - Financial
Statements and Supplementary Data below, but are not reflected as liabilities on our consolidated balance sheets. As of January 3, 2015, substantially all our stores were subject to leases, which have terms generally up to 20 years, and during Fiscal 2014 our operating lease expense from continuing operations was approximately $132.2 million.
In August 2010, the Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board (“IASB”) issued a joint discussion paper highlighting proposed changes to financial accounting standards for leases. Currently, Accounting Standards Codification 840 (“ASC 840”), Leases (formerly Statement of Financial Accounting Standards 13, Accounting for Leases) requires that operating leases are classified as an off-balance sheet transaction and only the current year operating lease expense is accounted for in the income statement. In order to determine the proper classification of our stores as either operating leases or capital leases, we must make certain estimates at the inception of the lease relating to the economic useful life and the fair value of an asset as well as select an appropriate discount rate to be used in discounting future lease payments. These estimates are utilized by management in making computations as required by existing accounting standards that determine whether the lease is classified as an operating lease or a capital lease. Substantially all of our store leases have been classified as operating leases, which results in rental payments being charged to expense over the terms of the related leases.
Additionally, operating leases are not reflected in our consolidated balance sheets, which means that neither a leased asset nor an obligation for future lease payments is reflected in our consolidated balance sheets. The proposed changes to ASC 840 would require that substantially all operating leases be recognized as assets and liabilities on our balance sheet. All entities would need to classify leases to determine how to recognize lease-related revenue and expense. Classification would be based on the portion of the economic benefits of the underlying asset expected to be consumed by the lessee over the lease term, for which classification would be based on the nature of the asset being leased. The right to use the leased property would be capitalized as an asset and the present value of future lease payments would be accounted for as a liability. The effective date has not been determined, and may require retrospective adoption. While we have not quantified the impact this proposed standard would have on our financial statements, if our current operating leases are instead recognized on the balance sheet, it will result in a significant increase in the liabilities reflected on our balance sheet and will likely impact our income statement in an amount which cannot be determined at this time.
Compliance with Section 404 of the Sarbanes-Oxley Act may negatively impact our results of operations and failure to comply may subject us to regulatory scrutiny and a loss of investors’ confidence in our internal control over financial reporting.
Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”) requires us and our independent registered accounting firm to perform an evaluation of our internal control over financial reporting and file management’s attestation with our Annual Report on Form 10-K each year. We have evaluated, tested and implemented internal controls over financial reporting to enable management to report on such internal controls under Section 404. However, we cannot assure you that the conclusions we reached as of January 3, 2015 will represent conclusions we or our independent registered public accounting firm reach in future periods. Failure on our part to comply with Section 404 may subject us to regulatory scrutiny and a loss of public confidence in the reliability of our financial statements. In addition, we may be required to incur costs in improving our internal control over financial reporting and hiring additional personnel. Any such actions could negatively affect our results of operations.
We will continue to incur significant increased costs as a result of operating as a public company, and our management will be required to divert attention from operational and other business matters to devote substantial time to public company requirements.
In February 2012, we completed an initial public offering. As a result, we are required to incur additional legal, accounting, compliance and other expenses that we did not incur as a private company. We are obligated to file with the SEC quarterly and annual information and other reports that are specified in Section 13 and other
sections of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). In addition, we are also subject to other reporting and corporate governance requirements, including certain requirements of the New York Stock Exchange (“NYSE”), and certain provisions of the Sarbanes-Oxley Act (“Sarbanes-Oxley”) and other regulations promulgated thereunder, which impose significant compliance obligations upon us. We must be certain that we have the ability to institute and maintain a comprehensive compliance function; establish internal policies; ensure that we have the ability to prepare financial statements that are fully compliant with all SEC reporting requirements on a timely basis; design, establish, evaluate and maintain a system of internal controls over financial reporting in compliance with Sarbanes-Oxley; involve and retain outside counsel and accounting and financial staff with the appropriate experience in connection with the above activities and maintain an investor relations function.
Sarbanes-Oxley, as well as rules subsequently implemented by the SEC and the NYSE, have imposed increased regulation and disclosure and have required enhanced corporate governance practices of public companies. Our efforts to comply with evolving laws, regulations and standards in this regard are likely to result in increased administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. These changes require a significant commitment of resources. We may not be successful in implementing or maintaining these requirements, any failure of which could materially adversely affect our business, results of operations and financial condition. In addition, if we fail to implement or maintain the requirements with respect to our internal accounting and audit functions, our ability to continue to report our operating results on a timely and accurate basis could be impaired. If we do not implement or maintain such requirements in a timely manner or with adequate compliance, we might be subject to sanctions or investigation by regulatory authorities, such as the SEC or NYSE. Any such actions could harm our reputation and the confidence of investors and customers in our company and could materially adversely affect our business and cause our share price to fall.
Failure to attract, train and retain qualified store-level and distribution-level employees could adversely affect our ability to carry out strategic initiatives and ultimately impact our financial performance.
The retail food industry is labor intensive. Our ability to meet our labor needs, including our needs for specialized workers, such as pharmacists, while controlling wage and labor-related costs, is subject to numerous external factors, including the availability of a sufficient number of qualified persons in the work force in the markets in which we are located, unemployment levels within those markets, unionization of the available work force, prevailing wage rates, changing demographics, health and other insurance costs and changes in employment legislation. Failure to do so could adversely affect our results of operations.
The loss of key employees could negatively affect our business.
A key component of our success is the experience of our key employees, including our Chairman, President and Chief Executive Officer, Robert Mariano, our Executive Vice President-Operations, Donald Rosanova and our Group Vice President and Chief Financial Officer, Michael Turzenski. These employees have extensive experience in our industry and are familiar with our business, systems and processes. In addition, Messrs. Mariano and Rosanova are key to our strategy of expansion into the Chicago market, due to their experience with, and understanding of, food retailing in that region. The loss of services of one or more of our key employees could impair our ability to manage our business effectively. We do not maintain key person life insurance on any employee.
The cost of providing employee benefits continues to increase and is subject to factors outside of our control.
We sponsor defined benefit pension plans, which are frozen with respect to benefit accruals and closed to new participants. Even though our employees are not accruing additional pension benefits under these plans, some of these pension plans are not fully funded. Our funding requirements vary based upon plan asset performance, interest rates and actuarial assumptions. Poorer than assumed asset performance and continuing low interest rates
would likely cause our required funding contributions to increase in the future. As of December 28, 2013, the accumulated benefit obligation and fair value of plan assets for our Company-sponsored defined benefit plans were $179.0 million and $177.0 million, respectively. As of January 3, 2015, the accumulated benefit obligation and fair value of plan assets for our Company-sponsored defined benefit plans were $217.8 million and $177.1 million, respectively.
In addition, we participate in one underfunded multi-employer pension plan on behalf of our union-affiliated supply chain employees, and we are required to make contributions to this plan under our collective bargaining agreement. This multi-employer pension plan is currently underfunded in part due to increases in the costs of benefits provided or paid under these plans as well as lower returns on plan assets over the past several years. The unfunded liability of this plan may result in increased future payments by us and other participating employers. This multi-employer plan in which we participate was deemed by the plan actuary to be in “critical status,” prompting federally mandated increases in our contributions to them. Going forward, our required contributions to this multi-employer plan could increase as a result of many factors, including the outcome of collective bargaining with the union, actions taken by trustees who manage the plan, government regulations, the actual return on assets held in the plan and the payment of a withdrawal liability if we choose to exit the plan. We expect meaningful increases in contribution expense as a result of required incremental plan contributions to reduce underfunding. Our risk of future increased payments may be greater if other participating employers withdraw from the plan and are not able to pay the total liability assessed as a result of such withdrawal, or if the pension plan adopts surcharges and/or increased pension contributions as part of a rehabilitation plan. For example, in recent years our share of plan underfunding has increased due to the withdrawal of participating employers that, because of their financial distress, were unable to pay contributions or their portion of the unfunded pension liability.
During the fourth quarter of 2012, we recognized a charge of $1.0 million related to an expected liability for the withdrawal of approximately 3% of its employees who participate in the United Food and Commercial Workers Unions and Employers Pension Fund (“UFCW Fund”). These employees resumed participation in the UFCW Fund and we therefore recognized a $1.0 million benefit during the third quarter of 2013 related to the reversal of the liability that was established in the fourth quarter of 2012. Subsequent to the withdrawal mentioned below, we no longer participate in this plan.
During Fiscal 2014, we exited the Minneapolis / St. Paul market by selling or closing all of our stores in that market. As a result, we expect to incur a withdrawal liability related to the three multi-employer pension plans in which the affected employees participate. We recorded a charge of $49.7 million for the estimated multi-employer pension withdrawal liability, which represents our best estimate absent demand letters from the multi-employer plans. Demand letters from the impacted multi-employer pension plans may be received in 2015, or later and the ultimate withdrawal liability may change from the currently estimated amount. Any future charge will be recorded in the period when the change is identified. We expect the liability will be paid out in quarterly installments, which vary by plan, over a period of up to 20 years. During the fourth quarter of Fiscal 2014, we received a preliminary notice from one of the plans, which required us to make the first quarterly installment during the fourth quarter of Fiscal 2014, and these quarterly installments will continue for 20 years. The amount of the payment was consistent with our estimates when the initial charge was recorded. The net present value of the liability was determined using a risk free interest rate.
Pursuant to the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), the Pension Benefit Guaranty Corporation (the “PBGC”) has the right, subject to satisfaction of certain statutory requirements, to involuntarily terminate our defined benefit pension plans (thus accelerating funding obligations), or enter into an alternative arrangement with us to prevent such termination. In March 2010, we were contacted by the PBGC expressing concern regarding the impact that the payment of a $150 million shareholder dividend could have on our ability to meet our obligations to our largest defined benefit pension plan. We subsequently entered into an amendment to our existing agreement with the PBGC that required us to make additional contributions to one of our Company-sponsored defined benefit pension plans, one of which we were required to make no later than
April 29, 2010 and one on each of the first two anniversaries thereafter, and for us to increase and continue the credit support in the form of the existing letter of credit with respect to our obligations under such agreement. We completed these steps in accordance with our agreement with the PBGC, and in December 2012 the PBGC agreed that we could reduce the amount of our letter of credit to the previous level. We cannot assure you that the PBGC will not seek to increase or accelerate our funding requirements under our defined benefit plans in the event our operating performance declines or we otherwise increase our indebtedness.
We also provide health benefits to substantially all of our full-time employees and to certain part-time employees depending on average hours worked. Even though employees generally pay a portion of the cost, our cost of providing these benefits has increased steadily over the last several years. We anticipate future increases in the cost of health benefits, partly, but not entirely, as a result of the implementation of federal health care reform legislation. If we are unable to control healthcare and pension costs, we may experience increased operating costs, which may adversely affect our financial condition and results of operations.
Variability in self-insurance liability estimates could significantly impact our results of operations.
We self-insure for workers’ compensation, general liability, automobile liability and employee health care benefits up to a set retention level, beyond which we maintain excess insurance coverage. Liabilities are determined using actuarial estimates of the aggregate liability for claims incurred and an estimate of incurred but not reported claims, on an undiscounted basis. Our accruals for insurance reserves reflect certain actuarial assumptions and management judgments, which are subject to a high degree of variability. The variability is caused by factors external to us such as: historical claims experience; medical inflation; legislative changes to benefit levels; trends relating to jury verdicts; and claim settlement patterns. Any significant variation in these factors could cause a material change to our reserves for self-insurance liabilities and may adversely affect our financial condition and results of operations.
Litigation may materially adversely affect our business, financial condition and results of operations.
Our operations are characterized by a high volume of customer traffic and by transactions involving a wide variety of product selections. These operations carry a higher exposure to consumer litigation risk when compared to the operations of companies operating in many other industries. Consequently, we may be a party to individual personal injury, product liability and other legal actions in the ordinary course of our business, including litigation arising from food-related illness. The outcome of litigation, particularly class action lawsuits and regulatory actions, is difficult to assess or quantify. Plaintiffs in these types of lawsuits may seek recovery of very large or indeterminate amounts, and the magnitude of the potential loss relating to such lawsuits may remain unknown for substantial periods of time. The cost to defend future litigation may be significant. There may also be adverse publicity associated with litigation that may decrease consumer confidence in our businesses, regardless of whether the allegations are valid or whether we are ultimately found liable. As a result, litigation may materially adversely affect our businesses, financial condition, results of operations and cash flows.
Various aspects of our business are subject to federal, state and local laws and regulations. Our compliance with these regulations may require additional capital expenditures and could materially adversely affect our ability to conduct our business as planned.
We are subject to federal, state and local laws and regulations relating to zoning, land use, environmental protection, work place safety, public health, community right-to-know, alcoholic beverage sales, tobacco sales and pharmaceutical sales. In particular, the states of Wisconsin and Illinois and several local jurisdictions regulate the licensing of supermarkets, including alcoholic beverage license grants. In addition, certain local regulations may limit our ability to sell alcoholic beverages at certain times. A variety of state programs regulate the production and sale of milk, including the price of raw milk, through federal market orders and price support programs. We are also subject to laws governing our relationship with employees, including minimum wage requirements, overtime, working conditions, disabled access and work permit requirements. Compliance with
new laws in these areas, or with new or stricter interpretations of existing requirements, could reduce the revenue and profitability of our stores and could otherwise materially adversely affect our business, financial condition or results of operations. Additionally, a number of federal, state and local laws impose requirements or restrictions on business owners with respect to access by disabled persons. Our compliance with these laws may result in modifications to our properties, or prevent us from performing certain further renovations.
Our pharmacy business is subject to, and influenced by, certain government laws and regulations, including those administered and enforced by Medicare, Medicaid, the Drug Enforcement Administration (the “DEA”), the Consumer Product Safety Commission, the U.S. Federal Trade Commission and the U.S. Food and Drug Administration. For example, the conversion of various prescription drugs to over-the-counter medications, a decrease in the rate at which new prescription drugs become available or the failed introduction of new prescription drugs into the market could materially adversely affect our pharmacy sales. The withdrawal of certain drugs from the market may also materially adversely affect our pharmacy business. Changes in third party reimbursement levels for prescription drugs, including changes in Medicare or state Medicaid programs, could also reduce our margins and have a material adverse effect on our business. In order to dispense controlled substances, we are required to register our pharmacies with the DEA and to comply with security, recordkeeping, inventory control and labeling standards.
In addition, our pharmacy business is subject to local regulations in the states where our pharmacies are located, applicable Medicare and Medicaid regulations and state and federal prohibitions against certain payments intended to induce referrals of patients or other health care business. Failure to properly adhere to these and other applicable regulations could result in the imposition of civil, administrative and criminal penalties including suspension of payments from government programs; loss of required government certifications; loss of authorizations to participate in, or exclusion from, government reimbursement programs such as Medicare and Medicaid; loss of licenses; significant fines or monetary penalties for anti-kickback law violations, submission of false claims or other failures to meet reimbursement program requirements and could materially adversely affect the continued operation of our business. Our pharmacy business is also subject to the Health Insurance Portability and Accountability Act, including its obligations to protect the confidentiality of certain patient information and other obligations. Failure to properly adhere to these requirements could result in the imposition of civil as well as criminal penalties.
We may experience negative effects to our reputation from real or perceived quality or health issues with our food products, which could have an adverse effect on our operating results.
We believe that a reputation for providing our customers with fresh, high-quality food products is an important component of our customer value proposition. Concerns regarding the safety or quality of our food products or of our food supply chain could cause consumers to avoid purchasing certain products from us, or to seek alternative sources of food, even if the basis for the concern is outside of our control. Food products containing contaminants could be inadvertently distributed by us and, if processing at the consumer level does not eliminate them, these contaminants could result in illness or death. Adverse publicity about these concerns, whether or not ultimately based on fact, and whether or not involving products sold at our stores, could discourage consumers from buying our products and have an adverse effect on our operating results. Furthermore, the sale of food products entails an inherent risk of product liability claims, product recall and the resulting negative publicity. Any such claims, recalls or adverse publicity with respect to our own-brand products may have an even greater negative effect on our sales and operating results, in addition to generating adverse publicity for our own-brand products. Any lost confidence in us on the part of our customers would be difficult and costly to re-establish. Any such adverse effect could significantly reduce our brand value. Issues regarding the safety of any food items sold by us, regardless of the cause, could have a substantial and adverse effect on our sales and operating results.
Certain risks are inherent in providing pharmacy services, and our insurance may not be adequate to cover any claims against us.
Pharmacies are exposed to risks inherent in the packaging and distribution of pharmaceuticals and other healthcare products, such as risks of liability for products which cause harm to consumers. Although we maintain professional liability insurance and errors and omissions liability insurance, we cannot guarantee that the coverage limits under our insurance programs will be adequate to protect us against future claims, or that we will be able to maintain this insurance on acceptable terms in the future, or at all. Our results of operations, financial condition or cash flows may be materially adversely affected if in the future our insurance coverage proves to be inadequate or unavailable, or there is an increase in the liability for which we self-insure, or we suffer harm to our reputation as a result of an error or omission.
If our goodwill becomes further impaired, we may be required to record significant charges to earnings in the future.
We have a significant amount of goodwill. As of January 3, 2015, we had goodwill of approximately $297.5 million, of which $173.0 million is related to our Wisconsin financial reporting unit and $124.5 million is related to our Illinois financial reporting unit. As of January 3, 2015, goodwill represented approximately 26.6% of our total assets as of such date. Goodwill is reviewed for impairment on an annual basis (as of the first day of the third quarter) or whenever events occur or circumstances change that would more likely than not reduce the fair value of are porting unit below its carrying amount. Fair value is determined based on the discounted cash flows and comparable market value of a reporting unit. An impairment charge is recorded for any excess of the carrying value of goodwill over the implied fair value of the assets and liabilities. Prior to the third quarter of Fiscal 2014, the entire group of company-owned retail stores were considered one reporting unit. Subsequent to the second quarter of Fiscal 2014, we reassessed our determination of reporting units based on the exit from the Minneapolis/St. Paul market, the continued growth of the Mariano’s banner and its management operating structure and determined that we had two financial reporting units. The two financial reporting units identified by us during Fiscal 2014 are related to our business in Wisconsin comprised of the Pick ’n Save, Copps and Metro Market banners and our business in Illinois comprised of the Mariano’s banner.
The fair value of each reporting unit of the Company is determined by using both the income approach and market approach. The income approach involves discounting management’s projections of future cash flows and a terminal value discounted at a discount rate which approximates the Company’s weighted average cost of capital (“WACC”). Key assumptions used in the income approach include future sales growth and same-store sales, gross margin and operating expenses trends, depreciation expense, taxes, capital expenditures, changes in working capital and discount rate. Projected future cash flows are based on management’s knowledge of the current operating environment and expectations for the future. The internal forecasts used by the Company assume that the Wisconsin market will stabilize and that the Illinois market will experience profitability similar to its Wisconsin stores when the newly opened Mariano’s stores within that market mature. The WACC incorporates equity and debt return rates observed in the market for a group of comparable public companies and is determined using an average debt to equity ratio of selected comparable public companies. The terminal value is based upon the projected cash flow for the final projected year, and is calculated using estimates of growth of the net cash flows based on our estimate of stable growth for each financial reporting unit. The market approach is based upon observed transactions in the marketplace, evidenced by trading multiples based upon estimated and actual sales and EBITDA. The sales and earnings multiples selected by the Company are based upon the average multiples of comparable public companies and then adjusted for factors including forecast risk, growth and profitability.
Determining the fair value of a reporting unit involves the use of significant estimates and assumptions. Determining fair value using an income approach requires that we make significant estimates and assumptions, including management’s long-term projections of cash flows, market conditions and appropriate discount rates. Our judgments are based on historical experience, current market trends and other information. In estimating future cash flows, we rely on internally generated forecasts for operating profits and cash flows, including capital expenditures. The rates used to discount projected future cash flows reflect a weighted average cost of capital
based on the our industry, capital structure and risk premiums including those reflected in the current market capitalization, and could change and therefore impact the fair value of our reporting units. Based on our annual impairment testing completed at the beginning of the third quarter of Fiscal 2012, 2013 and 2014, no impairment of goodwill was indicated.
During the fourth quarter of Fiscal 2012, our market capitalization experienced a significant decline. As a result, management believed that there were circumstances evident which indicated that the fair value of our reporting unit could be below its carrying amount. Management therefore updated its annual review of goodwill for impairment that had been completed in the third quarter of 2012 and concluded that the carrying amount of goodwill exceeded its estimated fair value, resulting in a pre-tax, non-cash impairment charge of $120.8 million ($106.4 million, net of income taxes) during the fourth quarter of Fiscal 2012.
In accordance with our policy, we qualitatively assessed our goodwill balance for indicators of impairment as of the first day of the third quarter of Fiscal 2014. During the third quarter of Fiscal 2014, our market capitalization experienced a sustained significant decline. As a result, management concluded that there were circumstances evident which indicated that the fair value of our reporting units could be below their carrying amounts. Management therefore updated its annual review of goodwill for impairment that had been completed as of the first day of the third quarter of Fiscal 2014 and concluded that the carrying amount of goodwill exceeded its estimated fair value, resulting in a pre-tax, non-cash impairment charge of $280.0 million ($247.1 million, net of income taxes) during the third quarter of Fiscal 2014.
Changes in the key assumptions used to determine fair value, including changes in estimates of future cash flows caused by unforeseen events or changes in market conditions could negatively affect one or both of our reporting units’ fair value and ultimately result in further impairment charges. We continuously monitor for events and circumstances that could negatively impact the key assumptions used in determining fair value of a reporting unit. Factors that could cause us to change our estimates of future cash flows include successful efforts by our competitors to gain market share in our Wisconsin markets resulting in decreased sales and earnings projections for the Wisconsin markets, unsuccessful implementation of our expansion in the Illinois market resulting in less than expected sales and earnings for the Illinois market, an increased competitive environment in any of our markets, our inability to compete effectively with other retailers, our inability to maintain price competitiveness and a deterioration in general economic conditions. Additional changes to the key assumptions that could negatively affect the fair value of our reporting units include changes to discount rates, fluctuations in the valuations of comparable companies and volatility in our stock price. In addition, a reduction in the estimated replacement cost for similar fixed assets could result in a decrease in the estimated fair value of our fixed assets, and declines in the market rents for properties similar to those that we occupy could result in a decrease in the estimated fair value of our intangible lease rights. Please see Results of Continuing Operations for a discussion of any factors that are currently present that may impact the fair value of the Company. An impairment of a significant portion of our goodwill could materially adversely affect our financial condition and results of operations.
Severe weather, natural disasters and adverse climate changes may materially adversely affect our financial condition and results of operations.
Severe weather conditions and other natural disasters in areas where we have stores or distribution facilities or from which we obtain the products we sell may materially adversely affect our retail or distribution operations or our product offerings and, therefore, our results of operations. Such conditions may result in physical damage to, or temporary or permanent closure of, one or more of our stores or distribution facilities, an insufficient work force in our markets, and/or temporary disruption in the supply of products, including delays in the delivery of goods to our stores or a reduction in the availability of products in our stores. In addition, adverse climate conditions and adverse weather patterns, such as drought or flood, that impact growing conditions and the quantity and quality of crops may materially adversely affect the availability or cost of certain products within our supply chain. Any of these factors may disrupt our businesses and materially adversely affect our financial condition, results of operations and cash flows.
Our business could be harmed by a failure of our information technology or administrative systems.
We rely on our information technology and administrative systems to effectively manage our business data, communications, supply chain, order entry and fulfillment and other business processes. The failure of our information technology or administrative systems to perform as we anticipate could disrupt our business and result in transaction errors, processing inefficiencies and the loss of sales and systems may be vulnerable to damage or interruption from circumstances beyond our control, including fire, natural disasters, systems failures, viruses and security breaches, including breaches of our transaction processing or other systems that could result in the compromise of confidential customer data. Any such damage or interruption could have a material adverse effect on our business, cause us to face significant fines, customer notice obligations or costly litigation, harm our reputation with our customers, require us to expend significant time and expense developing, maintaining or upgrading our information technology or administrative systems, or prevent us from paying our suppliers or employees, receiving payments from our customers or performing other information technology or administrative services on a timely basis.
If we experience a data security breach and confidential customer information is disclosed, we may be subject to penalties and experience negative publicity, which could affect our customer relationships and have a material adverse effect on our business.
We and our customers could suffer harm if customer information were accessed by third parties due to a security failure in our systems. The collection of data and processing of transactions require us to receive and store a large amount of personally identifiable data. This type of data is subject to legislation and regulation in various jurisdictions. Recently, data security breaches suffered by well-known companies and institutions have attracted a substantial amount of media attention, prompting state and federal legislative proposals addressing data privacy and security. If some of the current proposals are adopted, we may be subject to more extensive requirements to protect the customer information that we process in connection with the purchases of our products. We may become exposed to potential liabilities with respect to the data that we collect, manage and process, and may incur legal costs if our information security policies and procedures are not effective or if we are required to defend our methods of collection, processing and storage of personal data. Future investigations, lawsuits or adverse publicity relating to our methods of handling personal data could adversely affect our business, results of operations, financial condition and cash flows due to the costs and negative market reaction relating to such developments.
Energy costs are a significant component of our operating expenses, and increasing energy costs, unless offset by more efficient usage or other operational responses, may impact our profitability.
We utilize natural gas and electricity in our stores and distribution facilities and gasoline and diesel fuel in the trucks that deliver products to our stores. Increases in energy costs, whether driven by increased demand, decreased or disrupted supply or an anticipation of any such events, will increase the costs of operating our stores and distribution network and may increase the costs of our products. We may not be able to recover these rising costs through increased prices charged to our customers, and any increased prices may exacerbate the risk of customers choosing lower-cost alternatives. In addition, if we are unsuccessful in protecting against these increases in energy costs through long-term energy contracts, improved energy procurement, improved efficiency and other operational improvements, the overall costs of operating our stores will increase which would impact our profitability.
We may be unable to protect or maintain our intellectual property, which could results in customer confusion and adversely affect our business.
We believe that our intellectual property has substantial value and has contributed significantly to the success of our business. In particular, our trademarks, including our registered trademarks of Roundy’s and Pick ’n Save, and our common law trademarks of Copps and Mariano’s, are valuable assets that reinforce our customers’ favorable perception of our stores. From time to time, third parties have used names similar to ours, have applied
to register trademarks similar to ours and, we believe, have infringed or misappropriated our intellectual property rights. We respond to these actions on a case-by-case basis. The outcomes of these actions have included both negotiated out-of-court settlements as well as litigation.
Risks Related to the Ownership of Our Common Stock
Conflicts of interest may arise because some of our directors are representatives of Willis Stein.
Messrs. Larson and Stein, who are representatives of Willis Stein, serve on our board of directors. Willis Stein and entities controlled by them may hold equity interests in entities that directly or indirectly compete with us, and companies in which they currently invest may begin competing with us. As a result of these relationships, when conflicts between the interests of Willis Stein, on the one hand, and the interests of our other stockholders, on the other hand, arise, these directors may not be disinterested. Although our directors and officers have a duty of loyalty to us under Delaware law and our certificate of incorporation, transactions that we enter into in which a director or officer has a conflict of interest are generally permissible so long as (1) the material facts relating to the director’s or officer’s relationship or interest as to the transaction are disclosed to our board of directors and a majority of our disinterested directors, or a committee consisting solely of disinterested directors, approves the transaction, (2) the material facts relating to the director’s or officer’s relationship or interest as to the transaction are disclosed to our stockholders and a majority of our disinterested stockholders approves the transaction or (3) the transaction is otherwise fair to us. Under our amended and restated certificate of incorporation, representatives of Willis Stein are not required to offer to us any transaction opportunity of which they become aware and could take any such opportunity for themselves or offer it to other companies in which they have an investment, unless such opportunity is offered to them solely in their capacity as a director of ours. Our certificate of incorporation provides that the doctrine of “corporate opportunity” will not apply to Willis Stein, or any of our directors who are associates of, or affiliated with, Willis Stein, in a manner that would prohibit them from investing in competing businesses or doing business with our clients or guests. It is possible that the interests of Willis Stein and its affiliates may in some circumstances conflict with our interests and the interests of our other stockholders.
Market volatility may affect our stock price and the value of your investment.
The market price of our common stock may fluctuate significantly in response to a number of factors, most of which we cannot predict or control, including:
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announcements of new initiatives, commercial relationships, acquisitions or other events by us or our competitors;
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failure of any of our initiatives to achieve commercial success;
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fluctuations in stock market prices and trading volumes of securities of similar companies;
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general market conditions and overall fluctuations in U.S. equity markets;
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variations in our operating results, or the operating results of our competitors;
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changes in our financial guidance to investors and analysts or our failure to achieve such expectations;
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delays in, or our failure to provide, financial guidance;
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changes in securities analysts’ estimates of our financial performance or our failure to achieve such estimates;
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future changes in our dividend policy;
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sales of large blocks of our common stock, including sales by Willis Stein or by our executive officers or directors;
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additions or departures of any of our key personnel;
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changes in accounting principles or methodologies;
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changing legal or regulatory developments in the U.S. and other countries; and
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discussion of us or our stock price by the financial press and in online investor communities.
In addition, the stock market in general has experienced substantial price and volume volatility that is often seemingly unrelated to the operating performance of particular companies. These broad market fluctuations may cause the trading price of our common stock to decline. In the past, securities class action litigation has often been brought against a company after a period of volatility in the market price of its common stock. We may become involved in this type of litigation in the future. Any securities litigation claims brought against us could result in substantial expenses and the diversion of our management’s attention from our business.
We do not expect to pay any cash dividends for the foreseeable future.
The continued expansion of the Mariano’s banner will require substantial funding. Accordingly, we do not anticipate that we will pay any cash dividends on shares of our common stock for the foreseeable future. On December 2, 2013, we announced that our Board of Directors suspended the quarterly dividend in order to reallocate capital to execute our Mariano’s banner growth plan. Any determination to pay dividends in the future will be at the discretion of our Board of Directors and will depend upon results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our Board of Directors deems relevant. Because we are a holding company, our ability to pay cash dividends on our common stock is largely dependent upon the receipt of dividends or other distributions from our subsidiaries. In addition, we are currently limited in our ability to declare dividends or make distributions on account of our common stock (other than in the form of common stock) under the terms of the 2020 Notes, the 2014 Term Facility and the 2014 Revolving Facility.
Future sales of our common stock, or the perception in the public markets that these sales may occur, may depress our stock price.
As of February 27, 2015, there were 49,277,943 shares of our common stock outstanding. A large portion of our shares are held by a small number of persons and investment funds. Sales by these stockholders of a substantial number of shares could significantly reduce the market price of our common stock. Moreover, Willis Stein has rights, subject to some conditions, to require us to file registration statements covering the shares they currently hold, or to include these shares in registration statements that we may file for ourselves or other stockholders.
An aggregate of 5,656,563 shares of our common stock has been registered and reserved for future issuance under the 2012 Incentive Compensation Plan. As of February 27, 2015 there were 2,982,399 remaining shares available for issuance. These shares can be freely sold in the public market upon issuance, subject to satisfaction of applicable vesting provisions. If a large number of these shares are sold in the public market, the sales could reduce the trading price of our common stock.
Our future operating results may fluctuate significantly and our current operating results may not be a good indication of our future performance. Fluctuations in our quarterly financial results could affect our stock price in the future.
Our revenues and operating results have historically varied from period-to-period, and we expect that they will continue to do so as a result of a number of factors, many of which are outside of our control. If our quarterly financial results or our predictions of future financial results fail to meet the expectations of securities analysts and investors, our stock price could be negatively affected. Any volatility in our quarterly financial results may make it more difficult for us to raise capital in the future or pursue acquisitions that involve issuances of our stock. Our operating results for prior periods may not be effective predictors of our future performance.
Factors associated with our industry, the operation of our business and the markets for our products may cause our quarterly financial results to fluctuate, including:
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our ability to compete effectively with other retailers;
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our ability to maintain price competitiveness;
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ongoing economic uncertainty;
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the geographic concentration of our stores;
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our ability to achieve sustained sales and profitable operating margins at new stores;
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our ability to maintain or increase our operating margins;
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our ability to implement our expansion into the Chicago market on a timely basis;
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ordering errors or product supply disruptions in the delivery of perishable products;
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increases in commodity prices;
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our ability to protect or maintain our intellectual property;
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severe weather, and other natural disasters in areas in which we have stores or distribution facilities;
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the failure of our information technology or administrative systems to perform as anticipated;
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data security breaches and the release of confidential customer information;
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our ability to offset increasing energy costs with more efficient usage;
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negative effects to our reputation from real or perceived quality or health issues with our food products;
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our ability to retain and attract senior management and key employees;
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our ability to renegotiate expiring collective bargaining agreements and new collective bargaining agreements;
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our ability to satisfy our ongoing capital needs and unanticipated cash requirements;
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the availability of financing to pursue our expansion into the Chicago market on satisfactory terms or at all;
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additional indebtedness incurred in the future;
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our ability to retain and attract qualified store-and distribution-level employees;
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rising costs of providing employee benefits, including increased pension contributions due to unfunded pension liabilities;
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changes in law;
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risks inherent in packaging and distributing pharmaceuticals and other healthcare products;
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wartime activities, threats or acts of terror or a widespread regional, national or global health epidemic;
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changes to financial accounting standards regarding store leases;
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our high level of fixed lease obligations;
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claims made against us resulting in litigation; and
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further impairment of our goodwill.
Any one of the factors above or the cumulative effect of some of the factors referred to above may result in significant fluctuations in our quarterly financial and other operating results, including fluctuations in our key metrics. This variability and unpredictability could result in our failing to meet our internal operating plan or the
expectations of securities analysts or investors for any period. If we fail to meet or exceed such expectations for these or any other reasons, the market price of our shares could fall substantially and we could face costly lawsuits, including securities class action suits. In addition, a significant percentage of our operating expenses are fixed in nature and based on forecasted revenue trends. Accordingly, in the event of revenue shortfalls, we are generally unable to mitigate the negative impact on margins in the short term.
Anti-takeover provisions in our charter documents and Delaware law might discourage or delay attempts to acquire us that you might consider favorable.
Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that may make the acquisition of our company more difficult without the approval of our board of directors. These provisions include:
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a classified board of directors so that not all members of our board of directors are elected at one time;
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authorization of the issuance of undesignated preferred stock, the terms of which may be established and the shares of which may be issued without stockholder approval, and which may include super voting, special approval, dividend, or other rights or preferences superior to the rights of the holders of common stock;
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prohibition on stockholder action by written consent unless such action is recommended by either unanimous written consent of the board of directors or by unanimous vote of directors at a board meeting with a quorum, which requires that all stockholder actions not so approved be taken at a meeting of our stockholders;
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special meetings of our stockholders may only be called by a resolution adopted by a majority of our directors then in office or by the chairman;
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express authorization for our board of directors to make, alter, or repeal our amended and restated bylaws; and
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advance notice requirements for nominations for elections to our board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings.
In addition, we are governed by the provisions of Section 203 of the Delaware General Corporation Law (the “DGCL”) which limits the ability of stockholders owning in excess of 15% of our outstanding voting stock to merge or combine with us. Although we believe these provisions collectively provide for an opportunity to obtain greater value for stockholders by requiring potential acquirers to negotiate with our board of directors, they would apply even if an offer rejected by our board were considered beneficial by some stockholders. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management.
These anti-takeover provisions and other provisions under Delaware law could discourage, delay or prevent a transaction involving a change in control of our company, even if doing so would benefit our stockholders. These provisions could also discourage proxy contests and make it more difficult for stockholders to elect directors of their choosing and to cause us to take other corporate actions which they may desire.
ITEM 1B
ITEM 1B - UNRESOLVED STAFF COMMENTS
None.
ITEM 2
ITEM 2 - PROPERTIES
We lease all of our properties from unaffiliated parties, except for one of our stores, which we own. A typical store lease is for an initial 20-year term with four renewal options of five years each. The following table shows the number of stores operated by geographic market as of January 3, 2015:
Our Oconomowoc distribution facility operates under a long-term lease expiring in 2030 with five renewal options of five years each and our Mazomanie distribution facility operates under a long-term lease expiring in 2019 with two ten year renewal options. Our central commissary is located in Kenosha, Wisconsin and operates under a long-term lease expiring in 2020, with five renewal options of five years each. Our executive offices are located in a leased 115,000 square foot office facility in downtown Milwaukee, which expires in 2018, with three renewal options of five years each.
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
We are subject to various legal claims and proceedings which arise in the ordinary course of our business, including employment related claims, involving routine claims incidental to our business. Although the outcome of these routine claims cannot be predicted with certainty, we do not believe that the ultimate resolution of these claims will have a material adverse effect on our results of operations, financial condition or cash flows.
ITEM 4
ITEM 4 - MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5
ITEM 5 - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Shares of our common stock, traded under the symbol “RNDY”, have been publicly traded since February 8, 2012, when our common stock was listed and began trading on the New York Stock Exchange (“NYSE”). Accordingly, no market for our stock existed prior to February 8, 2012.
As of February 27, 2015, there were 57 holders of record of our common stock, and the closing price of our common stock was $4.07 per share as reported by the NYSE. Because many of our shares of common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders.
Common Stock Price
The following table shows the high and low sale prices per share of our common stock as reported on The New York Stock Exchange for each quarter during the fiscal year ended January 3, 2015.
Stock Performance Graph
The following graph compares the cumulative total stockholder return on Roundy’s common stock between February 8, 2012 and January 3, 2015, based on the market price of the common shares and assumes reinvestment of dividends, with the cumulative total return of companies in the Russell 2000 Stock Index and a peer group composed of comparable companies in the grocery retail sector.
(1) Assumes $100 invested on February 8, 2012, in Roundy’s, Inc., Russell 2000 and the Peer Group, with reinvestment of dividends.
(2) Peer Group consists of Kroger Co., SUPERVALU Inc., Weis Markets, Inc., Ingles Markets, Inc., Delhaize Group SA (ADR) and Koninklijke Ahold NV (ADR).
Issuer Purchases of Equity Securities
During the year ended January 3, 2015, there were no issuer purchases of equity securities.
Dividend Policy
Prior to December 2, 2013, we historically declared quarterly dividends of approximately $0.12 per share on all outstanding shares of common stock. Because we are a holding company, our cash flow and ability to pay dividends are dependent upon the financial results and cash flows of our operating subsidiaries and the distribution or other payment of cash to us in the form of dividends or otherwise. Distributions from our subsidiaries are subject to applicable law and any restrictions contained in our subsidiaries’ current or future debt agreements.
In addition, we are currently limited in our ability to declare dividends or make distributions on account of our common stock (other than in the form of common stock) under the terms of the 2020 Notes, the 2014 Term Facility and the 2014 Revolving Facility. In particular, the indenture governing the 2020 Notes generally provides that Roundy’s Supermarkets can pay dividends and make other distributions to its parent companies in an amount not to exceed (1) 50% of Roundy’s Supermarket’s consolidated net income for the period beginning September 29, 2013 and ending as of the end of the last fiscal quarter before the proposed payment for which financial statements are available, plus (2) 100% of the aggregate amount of cash and the fair market value of any assets or property received by Roundy’s Supermarkets after December 20, 2013 from the issuance and sale of equity interests of Roundy’s Supermarkets (subject to certain exceptions), plus (3) 100% of the aggregate amount of cash and the fair market value of any assets or property contributed to the capital of Roundy’s Supermarkets after December 20, 2013, plus (4) 100% of the aggregate amount received in cash and the fair market value of assets or property received after December 20, 2013 from the sale of certain investments or the sale of certain subsidiaries, provided that certain conditions are satisfied, including that Roundy’s Supermarkets has a consolidated interest coverage ratio for the most recent four fiscal quarters for which financial statements are available of at least 2.0 to 1.0. The restrictions on dividends and other distributions contained in the indenture are subject to certain exceptions, including (1) dividends and other distributions in an aggregate amount not to exceed $10.0 million in any calendar year, with unused amounts being carried forward to future periods and (2) other dividends and distributions in an aggregate amount not to exceed $20.0 million in the aggregate. Under our 2014 Term Facility, Roundy’s Supermarkets is only permitted to declare cash dividends on account of its capital stock for the purpose of funding the issuer’s expected dividend payments in an amount that does not exceed the sum of $30.0 million plus the available amount. The available amount is calculated based on 50% of consolidated net income plus other amounts in a manner similar to the amount available for payment of dividends under the 2020 Notes, provided (a) no payment or insolvency event of default is continuing or would result therefrom and (b) the consolidated senior secured leverage ratio (on a pro forma basis) does not exceed 3.75 to 1.00. Under the 2014 Revolving Facility, Roundy’s Supermarket’s is permitted to make restricted payments, which would include the payment of dividends, provided (a) no default or event of default is continuing under the 2014 Revolving Facility and (b) either (i) the fixed charge coverage ratio is greater than 1.00 to 1.00 and excess availability plus cash and cash equivalents exceeds certain specified amounts (averaged over past 30 days and immediately after giving effect to the transaction); or (ii) excess availability plus cash and cash exceeds certain greater specified amounts (averaged over past 30 days and immediately after giving effect to the transaction).
We paid cash dividends to holders of our equity securities in an aggregate amount of $150.0 million in Fiscal 2010, including approximately $79.2 million on account of our common stock. We did not pay any dividends on account of our common stock during Fiscal 2011. We paid dividends of $26.0 million, $21.7 million and $0.2 million on account of our common stock during Fiscal 2012, 2013 and Fiscal 2014, respectively. Dividend payments in Fiscal 2014 consisted of dividends accrued on vested restricted stock.
On December 2, 2013, we announced that our Board of Directors had suspended the quarterly dividend to reallocate capital to execute our Mariano’s growth plan. Any determination to pay dividends in the future will be at the discretion of our Board of Directors and will depend upon results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our Board of Directors deems relevant.
ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA
The following table presents selected historical consolidated statement of income, balance sheet, cash flow and operating data for the periods presented and should only be read in conjunction with Item 7
ITEM 7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction with the information included in Item 6 - Selected Financial Data and our consolidated financial statements and the notes to those statements included in Item 8 - Financial Statements and Supplementary Data of this Annual Report on Form 10-K. The statements in this discussion regarding our expectations of future performance, liquidity and capital resources and other non-historical statements in this discussion are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described under Item 1A - Risk Factors and “Forward-Looking Statements.” Our actual results may differ materially from those contained in or implied by any forward-looking statements.
Overview
We are a leading Midwest supermarket chain founded in 1872. We have achieved leading market positions in our Wisconsin markets and are the largest grocery retailer in the state of Wisconsin by net sales for Fiscal 2013, based on comparative data that we obtained from Metro Market Studies, Grocery Distribution Analysis and Guide, 2014. As of January 3, 2015, we operated 148 grocery stores in Wisconsin and Illinois under the Pick ’n Save, Copps, Metro Market and Mariano’s retail banners, which are served by our two strategically located distribution facilities and our food processing and preparation commissary.
Our net sales have increased over the last three years due to our expansion in the Illinois market. Also, as of January 3, 2015, we serve as the primary wholesaler for one independent Pick ’n Save retail store.
Since Fiscal 2009, we have been able to grow our net sales as a result of our expansion into the Illinois market , our value positioning and our distinctive merchandising strategies, especially those involving own-brand and perishable goods. In addition, we implemented several cost reduction measures during this period to help support our operating margins and cash flow, including initiatives to improve labor productivity throughout our operations. These initiatives, together with our efficient cost structure, have enabled us to continue to make targeted investments to lower our everyday retail prices in an effort to improve our competitive position within our markets.
During the third quarter of Fiscal 2014, we exited the Minneapolis / St. Paul market by selling or closing all of our stores in that market, which were operated under the Rainbow banner.
During the Fiscal 2014, we also closed our Stevens Point distribution facility and transferred those operations to our Oconomowoc distribution facility. The Stevens Point distribution facility was ultimately sold in the fourth quarter of Fiscal 2014.
Going forward, we plan to continue to maintain our market leadership and focus on growing same-store sales, opening new stores and increasing our cash flow. We intend to pursue same-store sales growth by continuing to focus on price competitiveness, improving our marketing efforts, selectively remodeling and relocating existing stores and enhancing and expanding our own-brand, perishable and prepared food offerings. In addition, we intend to continue our expansion into the Chicago market with plans to open four to five new stores per year in the Chicago market over the next several years.
As of January 3, 2015, we had 29 stores open in the Chicago market. Given its favorable competitive dynamics and attractive demographics, including a large population and above average household income, we believe the Chicago market provides us with a compelling expansion opportunity. We also plan to continue to support our operating margins and cash flow generation by implementing cost reduction measures, including initiatives to reduce inventory shrink and improve labor productivity throughout our operations and by focusing on higher margin products.
Factors Affecting Our Operating Results
Various factors affect our operating results during each period, including:
General Economic Conditions and Changes in Consumer Behavior
The overall economic environment and related changes in consumer behavior have a significant impact on our business. In general, positive conditions in the broader economy promote customer spending in our stores, while economic weakness results in a reduction of customer spending. Macroeconomic factors that can affect customer spending patterns, and thereby our results of operations, include employment rates, business conditions, changes in the housing market, the availability of credit, interest rates, tax rates and fuel and energy costs.
We believe that the impact of the current economic slowdown on our recent operating results has at least been partially mitigated by increased consumer preferences for meals at home. The recent economic environment has also led consumers to become more price sensitive and, as a result, consumers are increasingly purchasing own-brand products that offer a better value than national brands. Because own-brand items have a lower price point than national brands, as our own-brand sales mix increases, our overall net sales are reduced but our gross profit and gross margin improve.
Our Wisconsin markets also feature relatively stable local economies with diversified employer bases and stable to modestly growing populations. Although our markets have been impacted by the economic downturn, the unemployment rate in Wisconsin is lower than the national average.
Inflation and Deflation Trends
Inflation and deflation can impact our financial performance. During inflationary periods, our financial results can be positively impacted in the short term as we sell lower-priced inventory in a higher price environment if we are able to successfully pass those higher prices on to our customers. Over the longer term, the impact of inflation is largely dependent on our ability to pass through inventory price increases to our customers, which is subject to competitive market conditions. During deflationary periods, our operating results are generally adversely affected. In Fiscal 2010, food deflation in the food retail sector moderated and, beginning in early Fiscal 2011, we began to experience inflation in some commodity driven categories, which had a slight negative impact on our gross margins as price competition has partially limited our ability to immediately pass through higher prices on certain products. In Fiscal 2012, we again experienced deflationary trends, some of which were related to pricing and promotional activity, in several key product categories that negatively affected our same-store sales and margins. In Fiscal 2013, we experienced low to moderate inflation which we do not believe materially affected our same-store sales. In Fiscal 2014, we also experienced inflation in certain commodity driven categories, which negatively impacted our gross margins slightly, as we have not been able to pass along higher prices in certain instances.
Targeted Investments in Everyday Low Prices
In order to support our goal of offering a superior assortment of center store, fresh and organics, supported by everyday fair pricing and a great customer experience, we adjust our pricing in certain markets for select key product categories to better compete against supercenter pricing. In those markets and categories, we are going to market with a lower everyday price and fewer deep promotional offers. This is more efficient and we believe ultimately helps our overall price image.
Store Openings and Store Closings
Our operating results in any particular period are impacted by the timing of new store openings and store closings. For example, we typically incur higher than normal employee costs at the time of a new store opening
associated with set-up and other opening costs. During the first several months following a new store opening, operating margins are also affected by promotional discounts and other marketing costs and strategies associated with new store openings, as well as higher shrink and costs related to hiring and training new employees. A new store in one of our Wisconsin markets can take a year or more to achieve a level of operating profitability comparable to our company-wide average for existing stores, with a longer time horizon anticipated with respect to our new Chicago stores.
In addition, many of our new store openings in existing markets have had a near term negative impact on our same-store sales as a result of cannibalization from existing stores in close proximity. Over the longer term, we believe that any such cannibalization will be more than offset by future net sales growth and expanded market share. When we close underperforming stores, we expense the present value of any remaining future lease liabilities, net of expected sublease income, which negatively impacts our operating results during the period of the closure.
We also look for opportunities to relocate existing stores to improve location, lease terms or store layout. Relocated stores typically achieve a level of operating profitability comparable to our company-wide average for existing stores more quickly than new stores.
Changes in our store base during the periods presented are summarized below:
Expanded Own-brand Offering
Delivering high quality own-brand products is a key component of our pricing and merchandising strategy, as we believe it builds and deepens customer loyalty, enhances our value proposition, generates higher gross margins relative to national brands and improves the breadth and selection of our product offering. A strong own-brand offering has become an increasingly important competitive advantage in the retail food industry, given consumers’ growing focus on value and greater willingness to purchase own-brand products over national brands.
Our portfolio of own-brand items has increased from approximately 1,600 items at the end of Fiscal 2005 to approximately 7,100 as of January 3, 2015, with the percentage of sales from own-brand items increasing from 8.4% for Fiscal 2005 to 24.5% for Fiscal 2014. Because own-brand items have a lower price point than national brands, as our own-brand sales mix increases, our overall net sales are reduced but our gross profit and gross margin improve.
Developments in Competitive Landscape
The U.S. food retail industry is highly competitive. Our competitors include national, regional and local conventional supermarkets, national and regional supercenters, membership warehouse clubs, and alternative food retailers, such as natural foods stores, smaller specialty stores and farmers’ markets. In any particular financial period, our results of operations may be impacted by changes to the competitive landscape in one or
more of our markets, including as a result of existing competitors expanding their presence or new competitors entering our markets. For example, in recent years we have faced increased competition from the continued expansion of supercenters, such as Wal-Mart throughout our Wisconsin markets. In certain cases, the impact of these competitive supercenter openings has caused our net sales to decline in the near term. However, the longer term impact of supercenter openings on our overall net sales and market share is more difficult to predict and is dependent on a number of factors in a particular market, including strength of competition, the competitive response by us and other food retailers, and consumer shopping preferences. In some cases, smaller regional and independent grocers are displaced by supercenter openings, creating an opportunity for us to gain market share.
Our competitors will often implement significant promotional activities in an effort to gain market share, in particular in connection with new store openings. In order to remain competitive and maintain our market share, we sometimes elect to implement competing promotional activities, which may result in near term pressure on our operating margins unless we are able to implement corresponding cost saving initiatives. Changes in the competitive landscape in our markets may also impact our level of capital expenditures in the event we decide to remodel or relocate an existing store to improve our competitive position.
Interest Expense and Loss on Debt Extinguishment
Our interest expense in any particular period is impacted by our overall level of indebtedness during that period and changes in the interest rates payable on such indebtedness. In February 2012, we used all of the net proceeds that we received from our initial public offering (“IPO”), together with our indebtedness from our new senior credit facility, to repay all of our outstanding borrowings and other amounts owed under our old credit facilities. In connection with such repayment, we recorded a charge of approximately $8.0 million, net of tax, (of which $7.2 million is related to continuing operations), to write off all of our unamortized deferred financing costs and the unamortized original issue discount as well as prepayment penalties associated with such indebtedness and to reflect the related prepayment premiums. In 2013, we issued $200 million of Senior Secured Second Lien Notes (the “2020 Notes”) and used the proceeds to prepay approximately $148.0 million of our term loan (“2012 Term Loan”) and to fund the Chicago Stores Acquisition. In connection with the prepayment on the 2012 Term Loan, we recorded charge of approximately $2.1 million, net of tax, (of which $2.0 million is related to continuing operations), to write off a portion of our unamortized deferred financing costs and a portion of the unamortized original issue discount on the 2012 Term Loan. In Fiscal 2014, we refinanced our existing credit facilities (the “2014 Refinancing”), and entered into two new credit facilities, a $460 million term loan (the “New Term Facility”) and a $220 million asset-based revolving credit facility (the “New Revolving Facility”). We used the proceeds from the New Term Facility, together with existing cash, to repay our existing term loan, including all accrued interest thereon and related costs, fees and expenses. In connection with the 2014 Refinancing, we recognized a loss on debt extinguishment of $5.0 million, net of tax, (of which $4.7 million is related to continuing operations), which consisted primarily of the write-off of $4.8 million of previously capitalized financing costs, the $3.6 million write-off of a portion of the unamortized discount on the 2012 Term Loan, and certain fees and expenses of $0.6 million related to the New Term Facility. Going forward, our interest expense will include the amortization of the original issue discounts associated with our debt financing arrangements, including our New Term Facility and the 2020 Notes.
Stock Compensation
In connection with the completion of our IPO, we granted an aggregate of 819,286 shares of restricted stock to certain of our directors, executive officers and non-executive officers. During Fiscal 2012, we cancelled 62,348 shares of restricted stock that were granted to executives that are no longer with the Company, and granted an additional 73,110 shares to new directors and executive officers. The 2012 restricted stock grants for executive officers and non-executive officers associated with these grants will vest over five years and the restricted stock for our directors will vest over one year.
In Fiscal 2013, we granted 770,366 shares of restricted stock that will vest upon certain market performance metrics (the “2013 Market Awards”) and 460,717 shares of time-based restricted stock (the “2013 Time-Based
Awards”) to certain employees under the Plan. The 2013 Time-Based restricted stock vests over three years for employees and one year for non-employee directors. The 2013 Market Awards will vest after three years if certain specified market conditions are met. The market-based condition is a comparison of the total shareholder return (“TSR”) of the Company’s stock with the TSR of its peer group over the corresponding three year period as determined by the Compensation Committee of ours Board of Directors. These 2013 Market Awards also include a modifier based on the performance of our operating income as compared to its peer group. The number of shares ultimately vested will be determined based on the TSR metric and operating income results at the conclusion of the third year.
In Fiscal 2014, we granted 990,540 restricted stock units that will convert to common stock upon vesting. Of the total units granted, 543,180 units will vest based upon the passage of time (the “2014 Time-Based Awards”), 212,175 units will vest based upon certain market performance metrics related to TSR (the “2014 Market Awards”) and 235,185 units will vest based upon certain operating income performance metrics (the “2014 Performance Awards”). The 2014 Time-Based Awards vest over three years for employees and one year for non-employee directors. The 2014 Market Awards will vest after three years if certain specified market conditions are met based on the TSR performance of the Company as compared to a peer group. The number of 2014 Market Awards that will ultimately convert from units to shares will be determined based on the TSR metric at the conclusion of the third year and could be up to 200% of the number of units originally granted. The 2014 Performance Awards will vest after three years if certain operating income performance metrics of the Company are met during Fiscal 2014. The number of 2014 Performance Awards that will ultimately convert from units to shares will be determined based on the operating income performance metrics during Fiscal 2014 and vest at the conclusion of the third year and could be up to 200% of the number of units originally granted.
We recorded total stock-based compensation expense of $1.7 million and $2.3 million, both net of tax, in Fiscal 2013 and Fiscal 2014 respectively. We estimate that we will record compensation expense associated with the 2012, 2013 and 2014 grants of approximately $2.3 million for Fiscal 2015, $1.6 million for Fiscal 2016, and approximately $0.3 million for Fiscal 2017, in each case net of tax, and based upon the fair market value of each grant on the day of the grant.
How We Assess the Performance of Our Business
In assessing the performance of our business, we consider a variety of performance and financial measures. These key measures include net sales and same-store sales, gross profit, operating and administrative expenses and Adjusted EBITDA.
Net Sales and Same-Store Sales
We evaluate net sales because it helps us measure the impact of economic trends and inflation or deflation, the effectiveness of our marketing, promotional and merchandising activities, the impact of new store openings and store closings, and the effect of competition over a given period. Net sales represent product sales less returns and allowances and sales promotions. We derive our net sales primarily from the operation of retail grocery stores and to a much lesser extent from the independent distribution of food and non-food products to an independently-owned store (less than 1% of total net sales in Fiscal 2014). We recognize retail sales at the point of sale. We do not record sales taxes as a component of retail revenues as we consider ourselves a pass-through conduit for collecting and remitting sales taxes.
We also consider same-store sales to be a key indicator in evaluating our performance. Same-store sales controls for the effects of new store openings, making it a useful measure for period-to-period comparisons. Our practice is to include sales from a store in same-store sales beginning on the first day of the fifty-third week following the store’s opening. When a store that is included in same-store sales is remodeled or relocated, we continue to include sales from that store in same-store sales. This practice may differ from the methods that our competitors use to calculate same-store or “comparable” sales. As a result, data in this Annual Report on Form 10-K regarding our same-store sales may not be comparable to similar data made available by our competitors.
Various factors may affect our net sales and same-store sales, including:
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overall economic trends and conditions;
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consumer preferences and buying trends;
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our competition, including competitor store openings or closings near our stores;
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the pricing of our products, including the effects of inflation or deflation;
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the number of customer transactions in our stores;
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our ability to provide product offerings that generate new and repeat visits to our stores;
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the level of customer service that we provide in our stores;
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our in-store merchandising-related activities;
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our ability to source products efficiently; and
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the number of stores we open, remodel or relocate in any period.
Gross Profit
We use gross profit to measure the effectiveness of our pricing and procurement strategies as well as initiatives to increase sales of higher margin items and to reduce shrink. We calculate gross profit as net sales less cost of sales. Cost of sales includes product costs, inbound freight, warehousing costs, receiving and inspection costs, distribution costs, and depreciation and amortization expenses associated with our supply chain operations. The components of our cost of sales may not be identical to those of our competitors. As a result, data in this Annual Report on Form 10-K regarding our gross profit may not be comparable to similar data made available by our competitors.
Our cost of sales is directly correlated with our overall level of sales. Gross profit as a percentage of net sales is affected by:
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relative mix of products sold;
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shrink resulting from product waste, damage, theft or obsolescence;
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promotional activity; and
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inflationary and deflationary trends.
Operating and Administrative Expenses
We evaluate our operating and administrative expenses in order to identify areas where we can create savings, such as labor process improvements. Operating and administrative expenses consist primarily of personnel costs, sales and marketing expenses, depreciation and amortization expenses as well as other expenses associated with facilities unrelated to our supply chain network, internal management expenses and expenses for accounting, information systems, legal, business development, human resources, purchasing and other administrative departments.
Store-level labor costs are generally the largest component of our operating and administrative expenses. Store-level expenses, including labor, rent, utilities and maintenance, generally decrease as a percentage of net sales as our net sales increase. Accordingly, higher sales volumes allow us to leverage our store-level fixed costs to improve our operating margin.
The components of our operating and administrative expenses may not be identical to those of our competitors. As a result, data in this Annual Report on Form 10-K regarding our operating and administrative expenses may
not be comparable to similar data made available by our competitors. Our operating and administrative expenses have increased due to additional legal, accounting, insurance and other expenses incurred as a result of being a public company.
Adjusted EBITDA
We believe that Adjusted EBITDA is a useful performance measure and we use it to facilitate a comparison of our operating performance on a consistent basis from period-to-period and to provide for a more complete understanding of factors and trends affecting our business. We also use Adjusted EBITDA as one of the primary methods for planning and forecasting overall expected performance and for evaluating on a quarterly and annual basis actual results against such expectations, and as a performance evaluation metric in determining achievement of certain compensation programs and plans for employees, including our senior executives.
We define Adjusted EBITDA as earnings before interest expense, provision for income taxes, depreciation and amortization, LIFO charges, amortization of deferred financing costs, non-cash compensation expenses arising from the issuance of stock, costs incurred in connection with our IPO (or subsequent offerings of Roundy’s common stock), loss on debt extinguishment, certain non-recurring or unusual employee and pension related costs, costs related to acquisitions, costs related to debt financing activities, goodwill and asset impairment charges, gain or loss on the disposition of assets, one-time charges due to the closing of stores or a distribution facility and Adjusted EBITDA from discontinued operations. All of the omitted items are either (i) non-cash items or (ii) items that we do not consider in assessing our on-going operating performance. Because it omits non-cash items, we believe that Adjusted EBITDA is less susceptible to variances in actual performance resulting from depreciation, amortization and other non-cash charges and more reflective of other factors that affect our operating performance. Because it omits the other items, we believe Adjusted EBITDA is also more reflective of our on-going operating performance.
We determine the amount of the LIFO charges that we exclude in calculating Adjusted EBITDA by determining the base year values of beginning and ending inventories that we account for on a LIFO basis using cumulative price indexes as published by the Bureau of Labor Statistics and subtracting the current year difference between inventories calculated on a LIFO basis and the current cost of inventories valued on a FIFO basis.
Basis of Presentation
Our fiscal year is the 52 or 53 week period ending on the Saturday nearest to December 31. For the last three completed calendar years, our fiscal year ended on December 29, 2012, December 28, 2013 and January 3, 2015. For ease of reference, we identify our fiscal years in this Annual Report on Form 10-K by reference to the calendar year ending nearest to such date. For example, “Fiscal 2014” refers to our fiscal year ended January 3, 2015. Our fiscal years include 12 reporting periods, with an additional week in the eleventh reporting period for 53 week fiscal years. Fiscal 2012 and 2013 included 52 weeks and Fiscal 2014 included 53 weeks.
Results of Continuing Operations
Our results from continuing operations in any particular period are affected by the number of stores we have in operation during that period. The following table summarizes our store network for continuing operations as of the end of each of our last three fiscal years.
The following table sets forth various components of our consolidated statements of operations for Fiscal 2012, 2013 and 2014 from the audited consolidated financial statements included in Item 8 - Financial Statements and Supplementary Data in this Annual Report on Form 10-K, expressed both in dollars and as a percentage of net sales for the period indicated.
Fiscal 2014 Compared With Fiscal 2013
Net Sales. Net sales were $3.86 billion for 2014, an increase of $502.2 million, or 15.0% from $3.35 billion for 2013. Same-store sales decreased 2.9%, due to a 4.8% decrease in the number of customer transactions, partially offset by a 2.0% increase in the average transaction size.
Net sales for the Wisconsin markets were $2.71 billion for 2014, a decrease of $53.3 million, or 1.9% from $2.76 billion for 2013. The decrease primarily reflects a 4.2% decrease in same-store sales, partially offset by the impact of an additional week in 2014. The additional week in 2014 provided a benefit of approximately
$53 million in net sales. The decline in same-store sales was due to a 6.0% decrease in the number of customer transactions, partially offset by a 1.9% increase in the average transaction size. Same-store sales continue to be negatively impacted by competitive store openings in our Wisconsin markets.
Net sales for the Illinois market were $1.12 billion for 2014, an increase of $589.1 million, or 110.4% from $533.6 million for 2013. The increase primarily reflects the benefit of new and acquired stores in Illinois, the impact of an additional week in 2014, and a 3.9% increase in same-store sales. The additional week in 2014 provided a benefit of approximately $27 million in net sales. The increase in same-store sales was due to a 1.6% increase in the number of customer transactions and a 2.2% increase in the average transaction size.
As of January 3, 2015, we operated 148 retail grocery stores including 90 Pick ’n Save stores, 25 Copps stores, 29 Mariano’s stores and 4 Metro Market stores.
Gross Profit. Gross profit was $1.01 billion for 2014 and $0.88 billion for 2013. Gross profit, as a percentage of net sales, was 26.3% and 26.4% for 2014 and 2013, respectively. The decrease in gross profit as a percentage of net sales primarily reflects increased shrink (including the effect of the start-up impact of new or acquired Illinois stores) and price investments, partially offset by reduced promotional spend, an increased perishable sales mix and a benefit for the reduction in the LIFO reserve due to the disposition of inventory as a result of the closure of the Stevens Point Warehouse. Gross profit as a percentage of net sales in our Wisconsin and Illinois markets are similar.
Operating and Administrative Expenses. Operating and administrative expenses were $970.7 million for 2014, an increase of $172.0 million, or 21.5%, from $798.7 million for 2013. Operating and administrative expenses, as a percentage of net sales, was 25.2% and 23.8% for 2014 and 2013, respectively. The increase in the rate as a percentage of net sales was primarily due to increased start-up labor costs and higher occupancy and labor costs in new and acquired Illinois stores relative to the chain average, reduced fixed cost leverage in our Wisconsin markets resulting from lower sales, partially offset by the benefit of the additional week in 2014 which allowed for greater leveraging of fixed expenses. We also incurred $1.2 million in severance charges related to the closure of the Stevens Point Warehouse, $1.3 million in severance for corporate employees during Fiscal 2014 and a $7.0 million facility charge for two Wisconsin stores closed during Fiscal 2014.
Goodwill Impairment Charge. During the third quarter of Fiscal 2014, our market capitalization experienced a significant decline. As a result, management updated its annual review of goodwill for impairment and concluded that the carrying amount of goodwill exceeded its estimated fair value, resulting in a pre-tax, non-cash goodwill impairment charge of $280.0 million ($247.1 million after-tax) during Fiscal 2014.
Asset Impairment Charges. During Fiscal 2014, we recognized a non-cash asset impairment charge of $5.1 million related to adjustments to the carrying value of the property and equipment at the Stevens Point Warehouse which closed during Fiscal 2014.
Interest Expense. Interest expense includes interest on our outstanding indebtedness and amortization of deferred financing costs and original issue discount and is net of interest income earned on our invested cash.
Interest expense (including the amortization of deferred financing costs) was $56.3 million for 2014, an increase of $10.5 million, from $45.8 million for 2013. The increase was due primarily to interest expense on the 2020 Notes, partially offset by reduced interest expense on our term loan and the impact of the write-off of $3.5 million of unamortized loan costs in Fiscal 2013.
Loss on Debt Extinguishment. In connection with our debt refinancing in March 2014, we recognized a loss on debt extinguishment of $9.0 million, of which $8.6 million is related to continuing operations.
Income Taxes. Income tax benefit was $44.4 million for 2014, a decrease of $59.0 million, from a provision for income taxes of $14.5 million for 2013. The effective income tax rate was a benefit of (14.9%) for Fiscal 2014
and 36.0% for Fiscal 2013. The negative effective tax rate for 2014 reflects the impact of the goodwill impairment charge recorded during the third quarter of Fiscal 2014, the majority of which was non-deductible for tax purposes. The provision for income taxes and effective tax rate for 2013 included the effects of settlements of certain state income tax matters.
Fiscal 2013 Compared With Fiscal 2012
Net Sales. Net sales were $3.35 billion for 2013, an increase of $90.4 million, or 2.8% from $3.26 billion for 2012. Same-store sales decreased 2.2% due to a 4.4% decrease in the number of customer transactions, partially offset by a 2.2% increase in the average transaction size.
Net sales for the Wisconsin markets were $2.76 billion for 2013, a decrease of $106.3 million, or 3.7% from $2.87 billion for 2012. The decrease primarily reflects a 3.3% decrease in same-store sales. The decline in same-store sales was due to a 5.0% decrease in the number of customer transactions, partially offset by a 1.8% increase in the average transaction size. Our same-store sales were negatively impacted by the effect of competitive store openings, the mix shift to greater generic pharmacy sales and the weak economic environment in our Wisconsin markets.
Net sales for the Illinois market were $533.6 million for 2013, an increase of $235.7 million, or 79.1% from $297.9 million for 2012. The increase primarily reflects the benefit of new stores in Illinois and a 8.2% increase in same-store sales. The increase in same-store sales was due to a 2.7% increase in the number of customer transactions and a 5.3% increase in the average transaction size.
As of December 28, 2013, we operated 163 retail grocery stores including 93 Pick ’n Save stores, 29 Rainbow stores, 25 Copps stores, 13 Mariano’s stores and 3 Metro Market stores. The 27 Rainbow stores that were either sold or closed during Fiscal 2014 are included in discontinued operations.
Gross Profit. Gross profit was $0.88 billion for 2013 and $0.86 billion for 2012. Gross profit, as a percentage of net sales, was 26.4% and 26.5% for 2013 and 2012, respectively. The decrease in gross profit as a percentage of net sales primarily reflects increased shrink, including the effect of the higher perishable mix of Illinois stores and the start-up impact of new Illinois stores, partially offset by reduced promotional spend and an increased perishable sales mix. Gross profit as a percentage of net sales in our Wisconsin and Illinois markets are similar.
Operating and Administrative Expenses. Operating and administrative expenses were $798.7 million for 2013, an increase of $42.8 million, or 5.7%, from $755.9 million for 2012. Operating and administrative expenses, as a percentage of net sales, was 23.8% and 23.2% for 2013 and 2012, respectively. The increase was primarily due to increased occupancy and labor costs related to new stores as well as reduced fixed cost leverage in our Wisconsin markets resulting from lower sales.
Interest Expense. Interest expense (including the amortization of deferred financing costs) was $45.8 million for 2013, an increase of $1.6 million, from $44.2 million for 2012. The increase was primarily due to $3.5 million of unamortized loan costs, including $2.0 million of previously capitalized deferred financing costs and $1.5 million of the unamortized original issue discount on the 2012 Term Loan, both of which related to the prepayment on our 2012 Term Loan that occurred during the fourth quarter of 2013, offset by reduced interest rates on our 2012 Term Loan and decreased levels of indebtedness from our debt refinancing in the first quarter of 2012.
Income Taxes. Provision for income taxes was $14.5 million for 2013, an increase of $7.4 million, from $7.1 million for 2012. The effective income tax rates for 2013 and 2012 were 36.0% and (10.4%), respectively. The provision for income taxes and effective tax rate for 2012 reflects the impact of the goodwill impairment charge recorded during the fourth quarter of 2012, the majority of which is non-deductible for tax purposes.
DISCONTINUED OPERATIONS
During the second quarter of 2014, we entered into definitive agreements to sell 18 Rainbow stores in the Minneapolis / St. Paul market to a group of local grocery retailers (“Buyers”), including SUPERVALU INC. (“Rainbow Store Sale”). The aggregate sale price for the 18 Rainbow stores was $65 million in cash plus the proceeds from inventory that was sold to the Buyers at the closing of the Rainbow Store Sale. In addition, as part of the transaction, the Buyers assumed the lease obligations and certain multi-employer pension liabilities related to the acquired stores. The total proceeds received from the Rainbow Store Sale were $76.9 million, resulting in an overall gain of $1.7 million.
In addition, during the second quarter of 2014, we announced our intention to exit the Minneapolis / St. Paul market entirely. The remaining nine Rainbow stores not included in the Rainbow Store Sale were closed during the third quarter of 2014. We recorded a non-cash impairment charge of $11.1 million in the third quarter of Fiscal 2014 related to the assets of the nine Rainbow stores that were closed. We also recorded a $10.0 million closed facility charge during the third quarter of Fiscal 2014 related principally to the lease agreements for the nine closed store locations.
We incurred severance expense of approximately $2.2 million to the employees of the Rainbow stores that were sold or closed during the third quarter of Fiscal 2014.
As a result of the Rainbow Store Sale and the exit from the Minneapolis / St. Paul market, we expect to incur a withdrawal liability related to the multi-employer pension plans in which the affected employees participate. We recorded a charge of $49.7 million for the estimated multi-employer pension withdrawal liability, which represents our best estimate absent demand letters from the multi-employer plans. Demand letters from the impacted multi-employer pension plans may be received in 2015, or later and the ultimate withdrawal liability may change from the currently estimated amount. Any future charge will be recorded in the period when the change is identified. We expect the liability will be paid out in quarterly installments, which vary by plan, over a period of up to 20 years. The net present value of the liability was determined using a risk free interest rate. During the fourth quarter of Fiscal 2014, we received a preliminary notice from one of the plans, which required us to make the first quarterly installment during the fourth quarter of Fiscal 2014, and these quarterly installments will continue for 20 years. The amount of the payment was consistent with our estimates when the initial charge was recorded. The net present value of the liability was determined using a risk free interest rate.
Also in connection with the sale of the 18 Rainbow stores, we have assigned leases and subleases for these stores which expire at various dates through 2026. A remaining potential obligation exists in the event of a default under the assigned leases and subleases by the assignee. The potential obligations would include rent, real estate taxes, common area costs and other sundry expenses. The future minimum lease payments are approximately $38.9 million. We believe the likelihood of a liability related to these assigned leases and subleases is remote.
We have accounted for the 27 Rainbow stores that were either included in the Rainbow Store Sale or closed during the third quarter of Fiscal 2014 as discontinued operations. The Consolidated Balance Sheets as of December 28, 2013 and January 3, 2015 and the Consolidated Statements of Operations for Fiscal 2012, Fiscal 2013 and Fiscal 2014 have been reclassified to conform with this presentation.
We have included all direct costs and an amount of allocated interest expense (including amortization of deferred financing costs and loss on debt extinguishment charges) for the 27 Rainbow stores within net income (loss) from discontinued operations. Interest was allocated based on the ratio of the net assets of the 27 Rainbow stores as of the end of the period to the net assets of the total Company. We have allocated $8.4 million, $6.4 million and $3.8 million of interest to discontinued operations for Fiscal 2012, Fiscal 2013 and Fiscal 2014, respectively.
Net income (loss) from discontinued operations, net of tax, as presented in the Consolidated Statements of Operations (Loss) for Fiscal 2012, Fiscal 2013 and Fiscal 2014 is as follows (in thousands):
Liquidity and Capital Resources
Overview
Our principal sources of liquidity are cash flow generated from operations and borrowings under our asset-based revolving credit facility. Our principal uses of cash are to provide for working capital, finance capital expenditures, meet debt service requirements and pay stockholder dividends. The most significant components of our working capital are cash, inventories and accounts payable. Our working capital was $75.2 million at January 3, 2015, compared to $106.1 million at December 28, 2013. The decrease in working capital was due to decreased inventories related to discontinued operations and a decrease in cash, partially offset by increases in income tax receivable and prepaid expenses.
At January 3, 2015, we had $58.6 million of cash and cash equivalents and $172.7 million of availability under our New Revolving Facility. We also had an aggregate of $444.7 million of outstanding indebtedness under our New Term Facility (excluding unamortized discount of $9.8 million) and other long-term debt, notes payable of $200.0 million (excluding unamortized discount of $5.1 million), $11.9 million of capital lease obligations (excluding $16.3 million of capital lease obligations related to discontinued operations), no outstanding borrowings under our revolving credit facility and outstanding letters of credit of $29.6 million.
Initial Public Offering
On February 7, 2012, we priced the initial public offering of our common stock which began trading on the New York Stock Exchange on February 8, 2012. On February 13, 2012, we completed our offering of 22,059,091 shares of our common stock at a price of $8.50 per share, which included 14,705,883 shares sold by Roundy’s and 7,353,208 shares sold by existing shareholders. Roundy’s received approximately $125.0 million in gross proceeds from the IPO, or approximately $111.8 million in net proceeds after deducting the underwriting discount and expenses related to the offering. The net proceeds of our IPO were used to pay down the existing debt of Roundy’s Supermarkets, Inc. (“RSI”), the wholly owned operating subsidiary of the Company.
Offering of Common Stock
On February 12, 2014, we completed a public offering of 10,170,989 shares of our common stock at a price of $7.00 per share, which included 2,948,113 shares sold by Roundy’s and 7,222,876 shares sold by existing
shareholders. The Company received approximately $20.6 million in gross proceeds from the offering, or approximately $19.3 million in net proceeds after deducting the underwriting discount and expenses related to the offering. The net proceeds were used for general corporate purposes, including funding working capital and operating expenses as well as capital expenditures related to the eleven Dominick’s stores acquired from Safeway during the fourth quarter of 2013 in the Chicago Stores Acquisition.
2014 Credit Facilities
On March 3, 2014, RSI refinanced its existing credit facilities (the “2014 Refinancing”), and entered into two new credit facilities, a $460 million term loan (the “New Term Facility”) and a $220 million asset-based revolving credit facility (the “New Revolving Facility”, together with the New Term Facility, the “2014 Credit Facilities”). We used the proceeds from the New Term Facility, together with existing cash, to repay our existing term loan, including all accrued interest thereon and related costs, fees and expenses. The New Term Facility has a maturity date of March 3, 2021; provided that the maturity date will accelerate to September 15, 2020 if our 10.250% Senior Secured Notes due in 2020 (the “2020 Notes”) are not refinanced in full prior to such date. The New Revolving Facility has a maturity date of March 3, 2019.
The New Term Facility bears an interest rate, at our option, of (i) adjusted LIBOR (subject to a minimum floor of 1.00%) plus 4.75% or (ii) a base rate plus 3.75%.
The New Revolving Facility bears an interest rate, at our option, of (i) adjusted LIBOR plus a margin of 1.50%-2.00% per annum or (ii) a base rate plus a margin of 0.50%-1.00% per annum. In either case, the margin is based on RSI’s utilization of the New Revolving Facility. In addition, there is a quarterly fee payable in an amount equal to either 0.25% or 0.375% per annum of the undrawn portion of the New Revolving Facility. We may use borrowings under the New Revolving Facility for ongoing working capital and general corporate purposes and any other use not prohibited by the credit agreement governing the New Revolving Facility. Borrowing availability under the New Revolving Facility at any time is based on the value of certain eligible inventory, accounts receivable and pharmacy prescription files and is subject to additional reserves and other adjustments.
Mandatory prepayments under the New Term Facility will be required with (i) 50% of adjusted excess cash flow (which percentage shall be reduced to 25% and to 0% upon achievement of certain leverage ratios); (ii) 100% of the net cash proceeds of assets sales or other non-ordinary course dispositions of certain property by the RSI and its restricted subsidiaries (subject to certain exceptions and reinvestment provisions); and (iii) 100% of the net cash proceeds of issuances, offerings or placements of certain indebtedness not otherwise permitted to be incurred under the New Term Facility credit agreement.
The terms of the 2014 Credit Facilities contain customary affirmative covenants. The terms of the 2014 Credit Facilities also contain customary negative covenants, including restrictions on (i) dividends on, and redemptions of, equity interest and other restricted payment; (ii) liens and sale-leaseback transactions; (iii) loans and investments; (iv) guarantees and hedging agreements; (v) the sale, transfer or disposition of assets and businesses; (vi) transactions with affiliates; (vii) negative pledges and restrictions on subsidiary distributions; and (viii) optional payments and modifications of certain debt instruments.
2020 Notes
On December 20, 2013, RSI completed the private placement of $200 million of 2020 Notes that mature on December 15, 2020. The Company will pay interest at a rate of 10.25% on the 2020 Notes semiannually, commencing on June 15, 2014. The 2020 Notes were issued with a 3.01% discount, which will be amortized over the seven year term of the 2020 Notes. The Company capitalized $4.6 million of financing costs related to the issuance of the 2020 Notes which will be also amortized over the seven year term of the 2020 Notes.
The Company used the net proceeds from the issuance of the 2020 Notes to prepay approximately $148 million in principal amount of the Company’s outstanding term loan and to fund the Chicago Stores Acquisition. The
Company capitalized $0.6 million related to an amendment fee paid to lenders of the 2012 Credit Facilities. In addition, the Company expensed $3.5 million of unamortized loan costs, including $2.0 million of previously capitalized financing costs and $1.5 million of the unamortized discount on the Term Loan.
The 2020 Notes are unconditionally guaranteed, jointly and severally, on a senior basis, by (i) RSI’s indirect parent company Roundy’s, Inc., (ii) RSI’s direct parent company Roundy’s Acquisition Corp. and (iii) each of RSI’s domestic restricted subsidiaries owned on the date of original issuance of the 2020 Notes, and are secured by a second priority security interest in substantially all of our and the Guarantors’ assets, which security interests rank junior to the security interests in such assets that secure our 2014 Credit Facilities. The 2020 Notes and the guarantees thereof are secured by a second priority lien on substantially all the assets owned by RSI and the guarantors, subject to permitted liens and certain exceptions. These liens are junior in priority to the first-priority liens on the same collateral securing the 2014 Credit Facilities (as well as certain hedging and cash management obligations owed to lenders thereunder or their affiliates) and to certain other permitted liens under the indenture.
The indenture governing the 2020 Notes generally provides that RSI can pay dividends and make other distributions to its parent companies in an amount not to exceed (i) 50% of RSI’s consolidated net income for the period beginning September 29, 2013 and ending as of the end of the last fiscal quarter before the proposed payment for which financial statements are available, plus (ii) 100% of the aggregate amount of cash and the fair market value of any assets or property received by RSI after December 20, 2013 from the issuance and sale of equity interests of RSI (subject to certain exceptions), plus (iii) 100% of the aggregate amount of cash and the fair market value of any assets or property contributed to the capital of RSI after December 20, 2013, plus (iv) 100% of the aggregate amount received in cash and the fair market value of assets or property received after December 20, 2013 from the sale of certain investments or the sale of certain subsidiaries, provided that certain conditions are satisfied, including that RSI has a consolidated interest coverage ratio of greater than 2.0 to 1.0. The restrictions on dividends and other distributions contained in the indenture are subject to certain exceptions, including (i) the payment of dividends to permit any of its parent companies to pay taxes, general corporate and operating expenses, customary compensation of officers and employees of such parent companies and costs related to an offering of such parent company’s equity and (ii) dividends and other distributions in an aggregate amount not to exceed $10.0 million in any calendar year, with unused amounts being carried forward to future periods.
Prior Credit Facilities
Prior to the 2014 Refinancing, our long-term debt included a senior credit facility consisting of a $675 million term loan (the ‘‘2012 Term Loan’’) and a $125 million revolving credit facility (the ‘‘2012 Revolving Facility’’ and together with the 2012 Term Loan, the ‘‘2012 Credit Facilities”). Borrowings under the 2012 Credit Facilities bore an interest rate, at our option, of (i) adjusted LIBOR (subject to a 1.25% floor) plus 4.5% or (ii) an alternate base rate plus 3.5%.
Cash Flows
The following table presents a summary of our net cash provided by (used in) operating, investing and financing activities (in thousands):
(1) Includes activities from continuing operations and discontinued operations.
(2) Includes cash and cash equivalents included in assets of discontinued operations.
Net Cash Provided by Operating Activities. Net cash provided by operating activities in Fiscal 2013 was $104.0 million, compared to $105.7 million in Fiscal 2012. The decrease in cash provided by operating activities was due primarily to reduced operating income and timing of payments for payroll and employee benefits and income taxes, partially offset by reduced pension contributions and interest payments.
Net cash provided by operating activities in Fiscal 2014 was $48.0 million, compared to $104.0 million in Fiscal 2013. The decrease in cash provided by operating activities was due primarily to reduced operating income, timing of payments for accounts payable and increased interest payments, partially offset by reduced payments for income taxes.
Net Cash (Used in) Provided by Investing Activities. Net cash (used in) provided by investing activities consists primarily of capital expenditures for opening new stores and relocating and remodeling existing stores, as well as investments in information technology, store maintenance and our supply chain, as well as business acquisitions, offset by proceeds on the sale of assets.
Net cash used in investing activities was $61.6 million during Fiscal 2012. Net cash used during the period related primarily to capital expenditures of $62.0 million, partially offset by $0.5 million of proceeds from asset sales.
Net cash used in investing activities was $102.6 million during Fiscal 2013. Net cash used during the period related primarily to capital expenditures of $67.1 million and cash used for the Chicago Stores Acquisition of $36.0 million, partially offset by $0.5 million of proceeds from asset sales.
Net cash provided by investing activities was $1.3 million during Fiscal 2014. Net cash provided during the period related primarily to the proceeds of the Rainbow Store Sale of $76.9 million, the proceeds of the sale of the Stevens Point Warehouse of $15.0 million and proceeds from other asset sales of $1.2 million, partially offset by capital expenditures of $91.8 million.
Net Cash (Used in) Provided by Financing Activities. Net cash (used in) provided by financing activities consists primarily of payments on our debt and capital lease obligations, proceeds from debt borrowing, and payment of dividends to our shareholders.
Net cash used in financing activities was $58.4 million during Fiscal 2012. Net cash used during the period consisted of payments of debt and capital lease obligations of $791.6 million, primarily to refinance our existing indebtedness and related financing costs of $18.2 million, partially offset by the net proceeds from our 2012 Term Loan of $664.9 million and net proceeds from our initial public offering of $111.8 million. In addition, during 2012, we paid dividends to shareholders in the amount of $26.0 million.
Net cash provided by financing activities was $7.8 million during Fiscal 2013. Net cash used during the period consisted of the net proceeds of the 2020 Notes offering of $194.0 million, partially offset by payments of debt and capital lease obligations of $158.9 million, including the prepayment on our 2012 Term Loan of $148.0 million, as well as costs related to the 2020 Notes issuance and credit agreement amendment of $4.6 million and $0.6 million, respectively. In addition, during 2013, we paid dividends to shareholders in the amount of $21.7 million.
Net cash used in financing activities was $72.9 million during Fiscal 2014. Net cash used during the period primarily consisted of payments of debt and capital lease obligations of $536.4 million, primarily to refinance our existing indebtedness, including $15.3 million of payments on our New Term Facility, and related financing costs of $5.7 million, partially offset by the net proceeds from our term loan of $450.8 million and net proceeds from our common stock offering of $19.3 million.
Capital Expenditures
Total capital expenditures for Fiscal 2015 are estimated to be approximately $68-73 million.
Non-GAAP Measures
We present Adjusted EBITDA, a non-GAAP measure, to provide investors with a supplemental measure of our operating performance. We define Adjusted EBITDA as earnings before interest expense, provision for income taxes, depreciation and amortization, LIFO charges, amortization of deferred financing costs, non-cash compensation expenses arising from the issuance of stock, costs incurred in connection with our IPO (or subsequent offerings of our Roundy’s common stock), loss on debt extinguishment, certain non-recurring or unusual employee and pension related costs, costs related to acquisitions, costs related to debt financing activities, goodwill and asset impairment charges, gain or loss on the disposition of assets, one-time charges due to the closing of stores or a distribution facility and Adjusted EBITDA from discontinued operations. Omitting interest, taxes and the other items provides a financial measure that facilitates comparisons of our results of operations with those of companies having different capital structures. Since the levels of indebtedness, tax structures, and methodologies in calculating LIFO expense that other companies have are different from ours, we omit these amounts to facilitate investors’ ability to make these comparisons. Similarly, we omit depreciation and amortization because other companies may employ a greater or lesser amount of owned property, and because in our experience, whether a store is new or one that is fully or mostly depreciated does not necessarily correlate to the contribution that such store makes to operating performance. We believe that investors, analysts and other interested parties consider Adjusted EBITDA an important measure of our operating performance. Adjusted EBITDA should not be considered as an alternative to net income as a measure of our performance. Other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.
Adjusted EBITDA has limitations as an analytical tool, and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. The limitations of Adjusted EBITDA include: (i) it does not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments; (ii) it does not reflect changes in, or cash requirements for, our working capital needs; (iii) it does not reflect income tax payments we may be required to make; and (iv) although depreciation and amortization are non-cash charges, the assets being depreciated and amortized often will have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements.
To properly and prudently evaluate our business, we encourage you to review our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K and the reconciliation to Adjusted EBITDA from net income, the most directly comparable financial measure presented in accordance with GAAP, set forth in the table below. All of the items included in the reconciliation from net income to Adjusted EBITDA are either (i) non-cash items or (ii) items that management does not consider in assessing our on-going operating performance. In the case of the non-cash items, management believes that investors may find it useful to assess our comparative operating performance because the measures without such items are less susceptible to variances in actual performance resulting from depreciation, amortization and other non-cash charges and more reflective of other factors that affect operating performance. In the case of the other items that management does not consider in assessing our on-going operating performance, management believes that investors may find it useful to assess our operating performance if the measures are presented without these items because their financial impact may not reflect on-going operating performance.
The following is a summary of the calculation of Adjusted EBITDA for Fiscal 2012, 2013 and 2014 (in thousands):
Our principal sources of liquidity are cash flows generated from operations and borrowings under our asset-based revolving credit facility. Our principal uses of cash are to meet debt service requirements, finance capital expenditures, make acquisitions and provide for working capital. We expect that current excess cash, cash available from operations and funds available under our asset-based revolving credit facility will be sufficient to fund our operations, debt service requirements and capital expenditures for at least the next 12 months.
Our ability to make payments on and to refinance our debt, and to fund planned capital expenditures depends on our ability to generate sufficient cash in the future. This, to some extent, is subject to general economic, financial, competitive and other factors that are beyond our control. We believe that, based upon current levels of operations, we will be able to meet our debt service obligations when due. Significant assumptions underlie this belief, including, among other things, that we will continue to be successful in implementing our business strategy and that there will be no material adverse developments in our business, liquidity or capital requirements. If our future cash flow from operations and other capital resources are insufficient to pay our obligations as they mature or to fund our liquidity needs, we may be forced to reduce or delay our business
activities and capital expenditures, sell assets, obtain additional debt or equity capital or restructure or refinance all or a portion of our debt, on or before maturity. There can be no assurance that we would be able to accomplish any of these alternatives on a timely basis or on satisfactory terms, if at all. In addition, the terms of our existing and future indebtedness may limit our ability to pursue any of these alternatives.
Contractual Obligations
The following table of material debt and lease commitments for continuing operations at January 3, 2015 (See Notes 9 and 13 to the consolidated financial statements included within Item 8 - Financial Statements and Supplementary Data) summarizes the effect these obligations are expected to have on our cash flow in the future periods as set forth in the table below (in thousands):
(1) Includes principal payments on our new 2014 Term Facility, 2020 Notes and other long-term debt.
(2) Includes interest payments on the new 2014 Term Facility. Interest payments have been estimated based on the rate in effect for the new 2014 Term Facility on the date of the 2014 Refinancing. Interest payments do not include interest payments on the 2014 Revolving Facility. While we expect there will be borrowings and interest payments on the new 2014 Revolving Facility, those borrowings and related interest payments cannot be estimated. Interest obligations exclude amounts which have been accrued through January 3, 2015.
As of January 3, 2015, we have $0.3 million of unrecognized tax benefits. We believe it is reasonably possible that tax audit resolutions could reduce its unrecognized tax benefits by $0.3 million in the next twelve months. These amounts have been excluded from the contractual obligations table because a reasonably reliable estimate of the period of cash settlement with the respective taxing authorities cannot be determined due to uncertainty regarding the timing of future cash outflows associated with these liabilities.
Our purchase obligations are cancelable and therefore not included in the above table.
We have outstanding letters of credit that total approximately $29.6 million at January 3, 2015.
We are required to make contributions to our defined benefit plans. These contributions are required under the minimum funding requirements of Employee Retirement Pension Plan Income Security Act. Our estimated 2015 minimum required contributions to our defined benefit plans are approximately $0.2 million. Due to uncertainties regarding significant assumptions involved in estimating future required contributions to our defined benefit plans, such as interest rate levels, the amount and timing of asset returns and the impact of proposed legislation, we are not able to reasonably estimate our future required contributions beyond 2015.
The following table represents our material debt and lease commitments for discontinued operations at January 3, 2015 (See Note 5 the consolidated financial statements included within Item 8 - Financial Statements and Supplementary Data) summarizes the effect these obligations are expected to have on our cash flow in the future periods as set forth in the table below (in thousands):
(1) During Fiscal 2014, we exited the Minneapolis / St. Paul market by selling or closing all of our stores in that market. As a result, we expect to incur a withdrawal liability related to the three multi-employer pension plans in which the affected employees participate. We recorded a charge of $49.7 million for the estimated multi-employer pension withdrawal liability, which represents our best estimate absent demand letters from the multi-employer plans. Demand letters from the impacted multi-employer pension plans may be received in 2015, or later and the ultimate withdrawal liability may change from the currently estimated amount. Any future charge will be recorded in the period when the change is identified. We expect the liability will be paid out in quarterly installments, which vary by plan, over a period of up to 20 years. During the fourth quarter of Fiscal 2014, we received a preliminary notice from one of the plans, which required us to make the first quarterly payment during the fourth quarter of Fiscal 2014, and these payments will continue for 20 years. The amount of the payment was consistent with our estimates when the initial charge was recorded. In the table above, we have estimated that payments on the other two impacted plans will begin in the second quarter of Fiscal 2015. The timing of these payments may change based on when demand letters are received.
Off-Balance Sheet Items
General
We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating our business. With the exception of operating lease and pension obligations, we do not have any off-balance sheet arrangements or relationships with entities that are not consolidated into or disclosed in our financial statements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources. In addition, we do not engage in trading activities involving non-exchange traded contracts.
Multiemployer Plans
We contribute to one underfunded multi-employer pension plan on behalf of our union-affiliated employees. This underfunding has increased in part due to increases in the costs of benefits provided or paid under these plans as well as lower returns on plan assets. The unfunded liabilities of this plan may result in increased future payments by us and other participating employers. Going forward, our required contributions to this multi-employer plan could increase as a result of many factors, including the outcome of collective bargaining with the unions, actions taken by trustees who manage the plans, government regulations, the actual return on assets held in the plan and
the payment of a withdrawal liability if we choose to exit the plan. We expect meaningful increases in contribution expense as a result of required incremental plan contributions to reduce underfunding. Our risk of future increased payments may be greater if other participating employers withdraw from the plan and are not able to pay the total liability assessed as a result of such withdrawal, or if the pension plan adopts surcharges and/or increased pension contributions as part of a rehabilitation plan.
During the fourth quarter of 2012, we recognized a charge of $1.0 million related to an expected liability for the withdrawal of approximately 3% of our employees who participate in the United Food and Commercial Workers Unions and Employers Pension Fund (“UFCW Fund”). These employees resumed participation in the UFCW Fund and we therefore recognized a $1.0 million benefit during the third quarter of 2013 related to the reversal of the liability that was established in the fourth quarter of 2012. Subsequent to the withdrawal mentioned below, we no longer participate in this plan.
During Fiscal 2014, we exited the Minneapolis / St. Paul market by selling or closing all of its stores in that market. As a result, we expect to incur a withdrawal liability related to the three multi-employer pension plans in which the affected employees participate. We recorded a charge of $49.7 million for the estimated multi-employer pension withdrawal liability, which represents our best estimate absent demand letters from the multi-employer plans. Demand letters from the impacted multi-employer pension plans may be received in 2015, or later and the ultimate withdrawal liability may change from the currently estimated amount. Any future charge will be recorded in the period when the change is identified. We expect the liability will be paid out in quarterly installments, which vary by plan, over a period of up to 20 years. During the fourth quarter of Fiscal 2014, we received a preliminary notice from one of the plans, which required us to make the first quarterly installment during the fourth quarter of Fiscal 2014, and these quarterly installments will continue for 20 years. The amount of the payment was consistent with our estimates when the initial charge was recorded. The net present value of the liability was determined using a risk free interest rate.
Critical Accounting Policies and Estimates
The preparation of our financial statements in conformity with U.S. GAAP require us to make estimates, assumptions and judgments that affect amounts of assets and liabilities reported in the consolidated financial statements, the disclosure of contingent assets and liabilities as of the date of the financial statements and reported amounts of revenues and expenses during the year. We believe our estimates and assumptions are reasonable; however, future results could differ from those estimates.
Critical accounting policies reflect material judgment and uncertainty and may result in materially different results using different assumptions or conditions. We identified the following critical accounting policies and estimates: inventories, income taxes, discounts and vendor allowances, closed facility commitments, reserves for self-insurance, employee benefit plans, goodwill and impairment of long-lived assets. For a detailed discussion of accounting policies, please refer to the notes to the consolidated financial statements in Item 8 - Financial Statements and Supplementary Data.
Senior management of the Company has discussed the development and selection of the following critical accounting policies with the audit committee of our board of directors.
Inventories
Inventories are recorded at the lower of cost or market. Substantially all of our inventories consist of finished goods. Cost is calculated on a FIFO and a LIFO basis for approximately 62% and 38%, and 70% and 30%, of our inventories at December 28, 2013 and January 3, 2015, respectively. We use the link chain method for computing dollar value LIFO, whereby the base year values of beginning and ending inventories are determined using price indexes published by the Bureau of Labor Statistics. We use a combination of the retail inventory method (“RIM”) and weighted average cost method to determine the current cost of inventory before any LIFO reserve is
applied. Under RIM, the current cost of inventories and gross margins are calculated by applying a cost-to-retail ratio to the current retail value of inventories. The weighted average cost method is used for our supply chain and perishable store inventories and the RIM method is used for all other inventories. If the FIFO method had been used to determine cost of inventories for which the LIFO method is used, our inventories would have been higher by approximately $24.4 million and $21.2 million as of December 28, 2013 and January 3, 2015, respectively.
Income Taxes
We pay income taxes based on tax statutes, regulations and case law of the various jurisdictions in which we operate. At any one time, multiple tax years are subject to audit by the various taxing authorities. Income taxes are accounted for under the asset and liability method. Deferred income 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. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We recognize an income tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. The income tax benefit recognized in our financial statements from such a position is measured based on the largest estimated benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.
Discounts and Vendor Allowances
Purchases of product at discounted costs are recorded in inventory at the discounted cost until sold. Volume and other program allowances are accrued as a receivable when it is reasonably assured they will be earned and reduce the cost of the related inventory for product on hand or cost of sales for product already sold. Vendor allowances received to fund advertising and certain other expenses are recorded as a reduction of our expense for such related advertising or other expense, if such vendor allowances reimburse us for specific, identifiable and incremental costs incurred by us in selling the vendor’s product. Any excess reimbursement over our cost is classified as a reduction to cost of sales.
Closed Facility Commitments
In prior years, we leased store sites which we have subleased to qualified independent retailers at rates that are generally equal to the rent paid by us. We also lease store sites for our retail operations. Under the terms of the original lease agreements, we remain primarily liable for any properties that are subleased as well as our own retail stores. Should a retailer be unable to perform under the sublease or should we close underperforming stores, we would record a charge to earnings for the discounted cost of the remaining term of the lease and related costs, less any anticipated sublease income. Should the number of defaults by sublessees or store closures increase, or the actual sublease income be less than estimated, the remaining lease commitments we must record could have a material adverse effect on our operating results and cash flows. Early settlements of lease obligations with the landlord and the discount rate used to calculate the estimated liability will also impact recorded balances or future results.
Reserves for Self-Insurance
We are primarily self-insured for potential liabilities for workers’ compensation, general liability and prior to Fiscal 2013 and beginning in Fiscal 2014, employee health care benefits. It is our policy to record the liability based on claims filed and a consideration of historical claims experience, demographic factors and other actuarial assumptions for those claims incurred but not yet reported. Any projection of losses concerning these claims is subject to a considerable degree of variability. Among the causes of this variability are unpredictable external factors affecting future inflation rates, litigation trends, legal interpretations, benefit level changes and claim settlement patterns.
Employee Benefit Plans
Certain of our employees are covered by noncontributory defined benefit pension plans. U.S. GAAP requires that we recognize in our consolidated balance sheet a liability for plans which are underfunded or unfunded, or an asset for plans which are overfunded. U.S. GAAP also requires that we measure the benefit obligations and fair value of plan assets that determine our plans’ funded status as of our fiscal year end date. We historically have used a December 31 measurement date. For Fiscal 2014, we used a measurement date of January 3, 2015. We record, as a component of accumulated other comprehensive income/(loss), actuarial gains or losses that have not yet been recognized.
The determination of our obligation and expense for Company-sponsored pension plans is dependent upon assumptions we select for use by actuaries in calculating those amounts. Those assumptions are described in Note 11 to our consolidated financial statements and include the discount rate, the expected long-term rate of return on plan assets and the rate of future compensation increases. Actual returns on plan assets and changes in the interest rates used to determine the discount rate are accumulated and amortized over future periods. While we believe that our assumptions are appropriate, significant differences in our actual experience or significant changes in our assumptions, including the discount rate used and expected return on plan assets, may significantly impact pension expense and cash contributions in the future.
The objective of our discount rate assumptions was intended to reflect the rates at which the pension benefits could be effectively settled. Our methodology for selecting the discount rates as of January 3, 2015 was to match the plans’ cash flows to that of a yield curve that provides the equivalent yields on high-quality fixed income securities for each maturity. Benefit cash flows due in a particular year can theoretically be “settled” by “investing” them in high quality income securities that mature in the same year. The discount rates are the single rates that produce the same present value of cash flows. The selection of the 3.76% weighted average discount rate as of January 3, 2015 represents the equivalent rate constructed under a broad-market yield curve. We utilized a weighted average discount rate of 4.64% as of December 28, 2013. A 100 basis point increase in the discount rate would decrease the projected pension benefit obligation as of January 3, 2015, by approximately $30.5 million.
To determine the expected rate of return on pension plan assets, we consider current and forecasted plan asset allocations as well as historical and forecasted rates of return on various asset categories. For 2013 and 2014, we assumed a pension plan investment return rate of 8.25%. For our fiscal year ending January 2, 2016, we have assumed a pension plan investment return rate of 8.25%.
During Fiscal 2014, the Society of Actuaries finalized new mortality tables and a new mortality improvement scale, which reflect improved life expectancies and an expectation that the trend will continue into the future. For the purposes of measuring the benefit obligation as of January 3, 2015, we used the RP-2014 mortality tables, projected using the MP-2014 mortality improvement scale. The impact on the projected benefit obligation as of January 3, 2015 due to the adoption of the new mortality tables was an increase of $9.9 million.
Goodwill
We have a significant amount of goodwill. As of January 3, 2015, we had goodwill of approximately $297.5 million, of which $173.0 million is related to our Wisconsin financial reporting unit and $124.5 million is related to our Illinois financial reporting unit. As of January 3, 2015, goodwill represented approximately 26.6% of our total assets as of such date. Goodwill is reviewed for impairment on an annual basis (as of the first day of the third quarter) or whenever events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Fair value is determined based on the discounted cash flows and comparable market values of a reporting unit. If the fair value of any reporting unit is less than its carrying value, the fair value of the implied goodwill is calculated as the difference between the fair value of the reporting unit and the fair value of the underlying assets and liabilities, excluding goodwill. An impairment charge is recorded for any excess of the carrying value of goodwill over the implied fair value for each reporting unit.
Prior to the third quarter of Fiscal 2014, the entire group of company-owned retail stores were considered one reporting unit. Subsequent to the second quarter of Fiscal 2014, we reassessed our determination of reporting units based upon the exit from the Minneapolis/St. Paul market, the continued growth of the Mariano’s banner and its management operating structure and determined that we have two financial reporting units. The two financial reporting units identified during Fiscal 2014 are related to our business in Wisconsin comprised of the Pick ’n Save, Copps and Metro Market banners and the Company’s business in Illinois comprised of the Mariano’s banner.
The fair value of each reporting unit of the Company is determined by using both the income approach and market approach. The income approach involves discounting management’s projections of future cash flows and a terminal value discounted at a discount rate which approximates the Company’s weighted average cost of capital (“WACC”). Key assumptions used in the income approach include future sales growth and same-store sales, gross margin and operating expenses trends, depreciation expense, taxes, capital expenditures, changes in working capital and discount rate. Projected future cash flows are based on management’s knowledge of the current operating environment and expectations for the future. The internal forecasts used by the Company assume that the Wisconsin market will stabilize and that the Illinois market will experience profitability similar to its Wisconsin stores when the newly opened Mariano’s stores within that market mature. The WACC incorporates equity and debt return rates observed in the market for a group of comparable public companies and is determined using an average debt to equity ratio of selected comparable public companies. The terminal value is based upon the projected cash flow for the final projected year, and is calculated using estimates of growth of the net cash flows based on our estimate of stable growth for each financial reporting unit. The market approach is based upon observed transactions in the marketplace, evidenced by trading multiples based upon estimated and actual sales and EBITDA. The sales and earnings multiples selected by the Company are based upon the average multiples of comparable public companies and then adjusted for factors including forecast risk, growth and profitability.
Determining the fair value of a reporting unit involves the use of significant estimates and assumptions. Determining fair value using an income approach requires that we make significant estimates and assumptions, including management’s long-term projections of cash flows, market conditions and appropriate discount rates. Our judgments are based on historical experience, current market trends and other information. In estimating future cash flows, we rely on internally generated forecasts for operating profits and cash flows, including capital expenditures. The rates used to discount projected future cash flows reflect a weighted average cost of capital based on our industry, capital structure and risk premiums including those reflected in the current market capitalization, and could change and therefore impact the fair value of our reporting units. The inputs and assumptions used in the determination of fair value are considered level 3 inputs within the fair value hierarchy.
Changes in the key assumptions used to determine fair value, including changes in estimates of future cash flows caused by unforeseen events or changes in market conditions could negatively affect one or both of our reporting units’ fair value and ultimately result in an impairment charge. We continuously monitor for events and circumstances that could negatively impact the key assumptions used in determining fair value of the reporting unit. Factors that could cause us to change our estimates of future cash flows include successful efforts by our competitors to gain market share in our Wisconsin markets resulting in decreased sales and earnings projections for the Wisconsin markets, unsuccessful implementation of our expansion in the Illinois market resulting in less than expected sales and earnings for the Illinois market, an increased competitive environment in any of our markets, our inability to compete effectively with other retailers, our inability to maintain price competitiveness and a deterioration in general economic conditions. Additional changes to the key assumptions that could negatively affect the fair value of our reporting units include changes to discount rates, fluctuations in the valuations of comparable company valuations and volatility in our stock price. In addition, a reduction in the estimated replacement cost for similar fixed assets could result in a decrease in the estimated fair value of our fixed assets, and declines in the market rents for properties similar to those that we occupy could result in a decrease in the estimated fair value of our intangible lease rights. Please see Results of Continuing Operations for a discussion of any factors that are currently present that may impact the fair value of the Company. Based on
our annual impairment testing completed at the beginning of the third quarter of Fiscal 2011, 2012 and 2013, no impairment of goodwill was indicated. During the fourth quarter of Fiscal 2012, our market capitalization experienced a significant decline. As a result, management believed that there were circumstances evident which indicated that the fair value of our reporting unit could be below its carrying amount and management therefore updated its annual review of goodwill for impairment that had been completed as of the first day of the third quarter. With the assistance of a third party valuation firm, we completed the first step of the impairment evaluation process in comparing the fair value of our reporting unit to its carrying value. At that time the carrying value exceeded the fair value of our reporting unit and therefore, we completed the second step of the impairment evaluation. The second step calculates the implied fair value of the goodwill, which is compared to the carrying value of goodwill. The implied fair value of goodwill is calculated by valuing all of the tangible and intangible assets of the reporting unit at the hypothetical fair value, assuming the reporting unit had been acquired in a business combination. The excess fair value of the entire reporting unit over the fair value of its identifiable assets and liabilities is the implied fair value of the goodwill. Based upon the calculation of the implied fair value of goodwill, it was determined that the carrying value of the goodwill exceeded the implied fair value of goodwill, which resulted in a non-cash, pre-tax impairment charge of $120.8 million ($106.4 million, net of taxes) during the fourth quarter of Fiscal 2012.
In accordance with our policy, we qualitatively assessed our goodwill balance in our two reporting units for indicators of impairment as of the first day of the third quarter of Fiscal 2014. During the third quarter of Fiscal 2014, our market capitalization experienced a sustained significant decline. As a result, management concluded that there were circumstances evident which indicated that the fair value of our reporting units could be below their carrying amounts. With the assistance of a third party valuation firm, we completed the first step of the impairment evaluation process in comparing the fair value of our reporting units to their carrying value. At that time the carrying value exceeded the fair value of our financial reporting units and, therefore, we completed the second step of the impairment evaluation. Based upon the calculation of the implied fair value of goodwill, it was determined that the carrying value of the goodwill exceeded the implied fair value of goodwill, which resulted in a non-cash, pre-tax impairment charge of $280.0 million ($247.1 million, net of income taxes) during the third quarter of Fiscal 2014.
Impairment of Long-Lived Assets Other Than Goodwill
Long-lived assets are reviewed for potential impairment when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Recoverability of assets to be held and used is measured by comparison of the carrying value of such assets to the undiscounted future cash flows expected to be generated by such assets. If the carrying value of an asset exceeds its estimated undiscounted future cash flows, an impairment provision is recognized to the extent that the carrying amount of the asset exceeds its fair value. We consider factors such as historic or forecasted operating results, trends and future prospects, current market value, significant industry trends and other economic and regulatory factors in performing these analyses. Using different assumptions and definitions could result in a change in our estimates of cash flows and those differences could produce materially different results.
Item 7A
Item 7A - Quantitative and Qualitative Disclosures about Market Risk
The Company is exposed to financial market risks associated with interest rate and commodity prices.
Interest Rate Risk
We have a market risk exposure to changes in interest rates. We manage interest rate risk through the use of fixed and variable interest rate debt and interest rate hedging. The 2014 Credit Facilities provide a floor in the rates under which we are charged interest expense. Currently, the LIBOR rate is below the interest rate floor included in the 2014 Credit Facilities. Should the LIBOR rate exceed the floor provided in the 2014 Credit Facilities agreement, we would be required to make higher interest payments than we are currently making. On August 27,
2013, we entered into two one-year forward starting interest rate swaps (the “Swap”), which will mature on August 27, 2016, to hedge cash flows related to interest payments on a $75 million notional amount related to the 2012 Term Loan. On March 3, 2014, we completed the 2014 Refinancing and the Swap was not amended. Due to a change in certain of the critical terms of the New Term Facility, specifically the change in the interest rate floor, a certain portion of the Swap was deemed ineffective for Fiscal 2014. The amount is considered immaterial. The Swap effectively fixes the interest rate for $75 million of the New Term Facility. The Swap involves the receipt of floating interest rate amounts in exchange for fixed rate interest payments over the duration of the Swap without an exchange of the underlying principal amount. In accordance with ASC 815, we designated the Swap as a cash flow hedge. Even after giving effect to the Swap, we are exposed to risks due to fluctuations in the market value of the Swap and changes in interest rates with respect to the portion of our New Term Facility that is not covered by the Swap. A one percentage point increase in LIBOR above the 1.25% minimum floor would cause an increase to the interest expense on our borrowings under the New Term Facility of approximately $3.7 million, after giving effect to the Swap. We may engage in additional hedging activities related to our interest rate risk from time to time in the future.
Commodity Risk
We are subject to volatility in food costs as a result of market risk associated with commodity prices. Although we typically are able to mitigate these cost increases, our ability to continue to do so, either in whole or in part, and may be limited by the competitive environment we operate in. We manage our exposure to this risk primarily through pricing agreements with our vendors.
Item 8
Item 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of Roundy’s, Inc.;
We have audited the accompanying consolidated balance sheets of Roundy’s, Inc. as of January 3, 2015 and December 28, 2013, and the related consolidated statements of operations, comprehensive income (loss), shareholders’ equity (deficit) and cash flows for each of the three years in the period ended January 3, 2015. Our audits also included the financial statement schedule listed in the Index at Item 15 (a)(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 Roundy’s, Inc. at January 3, 2015 and December 28, 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended January 3, 2015, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Roundy’s, Inc.’s internal control over financial reporting as of January 3, 2015, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 13, 2015 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Milwaukee, Wisconsin
March 13, 2015
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of Roundy’s, Inc.;
We have audited Roundy’s, Inc. internal control over financial reporting as of January 3, 2015, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Roundy’s, Inc. management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Roundy’s, Inc. maintained, in all material respects, effective internal control over financial reporting as of January 3, 2015, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), consolidated balance sheets of Roundy’s, Inc. as of January 3, 2015 and December 28, 2013, and the related consolidated statements of operations, comprehensive income (loss), shareholders’ equity (deficit) and cash flows for each of the three years in the period ended January 3, 2015 and our report dated March 13, 2015 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Milwaukee, Wisconsin
March 13, 2015
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
See notes to consolidated financial statements.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(1) Includes activities from continuing operations and discontinued operations.
(2) Includes cash and cash equivalents included in assets of discontinued operations.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)
(In thousands)
See notes to consolidated financial statements.
ROUNDY’S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 29, 2012, DECEMBER 28, 2013 AND JANUARY 3, 2015
1. ORGANIZATION
Roundy’s, Inc. (“Roundy’s” or the “Company”) is a corporation formed in 2010 for the purpose of owning and operating Roundy’s Acquisition Corp. (“RAC”), and its 100% owned subsidiary, Roundy’s Supermarkets, Inc. (“RSI”).
Roundy’s is a leading food retailer in the state of Wisconsin. As of January 3, 2015, Roundy’s owned and operated 148 retail grocery stores, of which 119 are located in Wisconsin and 29 are located in Illinois. Roundy’s also distributes a full line of food and non-food products from two wholesale distribution facilities and provides services to one independent licensee retail grocery store in Wisconsin.
As discussed in Note 5 below, in the third quarter of Fiscal 2014, the Company exited the Minneapolis / St. Paul market by selling or closing all of its stores in that market.
As discussed in Note 6 below, during the third quarter of Fiscal 2014, the Company closed its Stevens Point distribution facility and transferred those operations to its Oconomowoc distribution facility. The Stevens Point distribution facility was subsequently sold in the fourth quarter of Fiscal 2014.
Initial Public Offering-On February 7, 2012, Roundy’s priced the initial public offering (the “IPO”) of its common stock which began trading on the New York Stock Exchange on February 8, 2012. On February 13, 2012, Roundy’s completed the offering of 22,059,091 shares of its common stock at a price of $8.50 per share, which included 14,705,883 shares sold by Roundy’s and 7,353,208 shares sold by existing shareholders. Roundy’s received approximately $125.0 million in gross proceeds from the IPO, or approximately $111.8 million in net proceeds after deducting the underwriting discount and expenses related to the offering. The net proceeds of the IPO were used to pay down RSI’s existing debt.
A summary of Roundy’s capitalization upon closing of the IPO is as follows (in thousands):
On January 24, 2012, the Board of Directors approved an amendment to the articles of incorporation to increase the number of shares Roundy’s is authorized to issue to 150,000,000 shares of common stock and 5,000,000 shares of preferred stock, and to convert all of its outstanding preferred stock into shares of common stock on a one-for-one basis. Subsequent to the preferred stock conversion, the Board of Directors approved an approximately 292.2-for-one stock split on all common shares outstanding as of that date. In accordance with applicable accounting rules, the Company has restated all of the historical common share and per share amounts for the periods presented to give retroactive effect to this 292.2-for-one common stock split but have not given retroactive effect to the conversion of preferred stock into common stock. Therefore, the 10,439 shares of outstanding preferred stock at December 31, 2011 are reflected as having been converted and then subsequently split in January 2012.
2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation-The accompanying consolidated financial statements include the accounts of Roundy’s and its subsidiaries, all of which are wholly owned. All significant intercompany accounts and
transactions have been eliminated in consolidation. Unless otherwise indicated, all references in these consolidated financial statements to “the Company”, “Roundy’s” or similar words are to Roundy’s, Inc. and its subsidiaries.
Reclassifications-The Company has classified the 27 Rainbow stores which were sold or closed in the third quarter of Fiscal 2014 as discontinued operations for the years ended December 29, 2012, December 28, 2013 and January 3, 2015. Prior year balances have been reclassified to conform with the current presentation of discontinued operations. Unless otherwise indicated, references to the Consolidated Statement of Operations and the Consolidated Balance Sheet in the Notes to the Consolidated Financial Statements exclude all amounts related to discontinued operations. See Note 5 for additional information regarding the discontinued operations.
Fiscal Year-The Company’s fiscal year is the 52 or 53 week period ending on the Saturday nearest to December 31. The years ended December 29, 2012 (“Fiscal 2012”) and December 28, 2013 (“Fiscal 2013”) included 52 weeks. The year ended January 3, 2015 (“Fiscal 2014”) included 53 weeks.
Use of Estimates-The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Management reviews its estimates on an ongoing basis, including those related to allowances for doubtful accounts and notes receivable, valuation of inventories, self-insurance reserves, closed facilities reserves, purchase accounting estimates, useful lives for depreciation and amortization of property and equipment, litigation based on currently available information and withdrawal liabilities for multi-employer pension plans related to discontinued operations, as discussed in Note 5. Changes in facts and circumstances may result in revised estimates and actual results could differ from those estimates.
Revenue Recognition-Retail revenues are recognized at the point of sale. Discounts provided to customers by the Company at the time of sale, including those provided in connection with loyalty cards, are recognized as a reduction of sales as the products are sold. Discounts provided by vendors, usually in the form of paper coupons, are not recognized as a reduction in sales provided the coupons are redeemable at any retailer that accepts coupons. The Company records a receivable from the vendor for the difference in sales price and payment received from the customer. Sales taxes are not recorded as a component of retail revenues as the Company considers itself a pass-through conduit for collecting and remitting sales taxes.
The Company records deferred revenue when Roundy’s gift cards are sold. A sale is then recognized when the gift card is redeemed to purchase product from the Company. Gift card breakage is recognized when redemption is deemed remote. The amount of breakage has not been material in Fiscal 2012, Fiscal 2013 or Fiscal 2014.
Independent distribution revenues are recognized, net of any estimated returns and allowances, when product is shipped, collectability is reasonably assured, and title has passed.
Cost of Sales-Cost of sales includes product costs, inbound freight, warehousing costs, receiving and inspection costs, distribution costs, and depreciation and amortization expenses associated with supply chain operations.
Purchases of product at discounted costs are recorded in inventory at the discounted cost until sold. Volume and other program allowances are accrued as a receivable when it is reasonably assured they will be earned and reduce the cost of the related inventory for product on hand or cost of sales for product already sold. Vendor allowances received to fund advertising and certain other expenses are recorded as a reduction of the Company’s expense for such related advertising or other expense if such vendor allowances reimburse the Company for specific, identifiable and incremental costs incurred in selling the vendor’s product. Any excess reimbursement over cost is classified as a reduction to cost of sales.
Vendor allowances for volume and other program allowances and allowances to fund advertising related expenses from continuing operations totaled $99.2 million, $90.3 million and $95.0 million for Fiscal 2012, Fiscal 2013 and Fiscal 2014, respectively.
Operating and Administrative Expenses-Operating and administrative expenses consist primarily of personnel costs, sales and marketing expenses, depreciation and amortization expenses and other expenses associated with facilities unrelated to supply chain operations, internal management expenses and expenses for finance, legal, business development, human resources, purchasing and other administrative departments. Pre-opening costs associated with opening new and remodeled stores are expensed as incurred. The Company expenses advertising costs as incurred. Advertising expenses from continuing operations totaled $19.6 million, $20.1 million, and $21.8 million for Fiscal 2012, Fiscal 2013 and Fiscal 2014, respectively.
Interest Expense-Interest expense includes interest on the Company’s outstanding indebtedness and is net of interest income earned on invested cash.
Income Taxes-The provision for federal income tax is computed based upon our consolidated tax return. The provision for state income tax is computed based upon the tax returns the Company files in the appropriate tax jurisdictions. The Company provides for income taxes in accordance with Accounting Standards Codification (“ASC”) 740 “Income Taxes,” which requires an asset and liability approach to financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. The Company periodically reviews tax positions taken or expected to be taken, and income tax benefits are recognized for those positions for which it is more likely than not will be upheld upon examination by taxing authorities. We recognize the settlement of certain tax positions based upon criteria under which a position may be determined to be effectively settled.
Comprehensive Income (Loss)-Comprehensive income (loss) refers to revenues, expenses, gains and losses that are not included in net income (loss) but rather are recorded directly in shareholders’ equity in the consolidated statements of shareholders’ equity (deficit). The Company’s other comprehensive income (loss) is comprised of the adjustments for pension liabilities and the fair value of interest rate swaps.
Fair Value of Financial Instruments-ASC 820, “Fair Value Measurements and Disclosures,” (“ASC 820”) defines fair value, establishes a framework for measuring fair value and requires additional disclosures about fair value measurements. ASC 820 prioritizes the inputs to valuation techniques used to measure fair value into the following hierarchy:
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Level 1: Unadjusted quoted prices are available in active markets for identical assets or liabilities that can be accessed at the measurement date;
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Level 2: Inputs other than quoted prices included within Level 1 that are directly or indirectly observable for the asset or liability;
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Level 3: Unobservable inputs for which little or no market activity exists.
The Company has one item carried at (or adjusted to) fair value in the consolidated financial statements as of January 3, 2015, which is an interest rate swap liability of $0.6 million. Interest rate derivatives are valued using forward curves and volatility levels as determined on the basis of observable market inputs when available and on the basis of estimates when observable market inputs are not available. These forward curves are classified as Level 2 within the fair value hierarchy. The fair value of the interest rate swap as of December 28, 2013 was a liability of $0.4 million.
The carrying values of the Company’s cash and cash equivalents, notes and accounts receivable and accounts payable approximated fair value as of January 3, 2015.
Based on estimated market rents for those leased properties which are recorded as capital leases, the fair value of capital lease obligations is approximately $28.2 million and $24.3 million, as of December 28, 2013 and January 3, 2015, respectively. Included in the fair value of capital lease obligations is $16.0 million and $11.3 million as of December 28, 2013 and January 3, 2015, respectively, related to the capital lease obligations for the nine Rainbow stores that were closed during the third quarter of Fiscal 2014 and the capital lease obligations for the 18 Rainbow stores that were sold during the third quarter of Fiscal 2014, both of which are included in liabilities of discontinued operations on the Consolidated Balance Sheet. The Company considers the fair value of the capital leases to be Level 2 within the fair value hierarchy.
Based on recent open market transactions of the Company’s New Term Facility and the 2020 Notes, the fair value of long-term debt, including current maturities, is approximately $732.7 million and $600.9 million as of December 28, 2013 and January 3, 2015, respectively. The Company considers the fair value of the New Term Facility and 2020 Notes to be Level 2 within the fair value hierarchy.
Cash Equivalents-The Company considers all highly liquid investments with maturities of three months or less when acquired to be cash equivalents. Accounts payable includes $53.2 million and $71.6 million at December 28, 2013 and January 3, 2015, respectively, of checks written in excess of related bank balances but not yet presented to banks for collection.
Accounts Receivable-The Company is exposed to credit risk with respect to accounts receivable. The Company continually monitors its receivables with vendors and customers by evaluating the collectability of accounts receivable based on a combination of factors, namely aging and historical trends. An allowance for doubtful accounts is recorded based on the likelihood of collection based on management’s review of the facts. Accounts receivable are written off after all collection efforts have been exhausted.
Inventories-Inventories are recorded at the lower of cost or market. Substantially all of the Company’s inventories consist of finished goods. Cost is calculated on a first-in-first-out (“FIFO”) and last-in-first-out (“LIFO”) basis for approximately 62% and 38%, and 70% and 30%, of inventories at December 28, 2013 and January 3, 2015, respectively. If the FIFO method was used to calculate the cost for the Company’s entire inventory, inventories would have been approximately $24.4 million and $21.2 million greater at December 28, 2013 and January 3, 2015, respectively.
Additionally, cost of sales would have been approximately $0.3 million greater during Fiscal 2012, $0.2 million greater during Fiscal 2013, and $0.4 million greater during Fiscal 2014, respectively, had the Company not experienced a reduction in inventory quantities that are valued under the LIFO method.
Cost is determined using the retail inventory method for all retail inventories, which totals approximately 66% and 74% of total inventories at December 28, 2013 and January 3, 2015, respectively. Cost for supply chain inventory is determined based on the weighted average costing method and such inventory totals 34% and 26% of total inventories at December 28, 2013 and January 3, 2015, respectively.
The Company records an inventory shrink adjustment based on a physical count and also provides an estimated inventory shrink adjustment for the period between the last physical inventory count and each balance sheet date. The Company performs physical counts of perishable store inventories approximately every month and nonperishable store inventories at least twice per year. The adjustments resulting from the physical inventory counts have been consistent with the inventory shrink estimates provided for in the consolidated financial statements.
Property and Equipment-Property and equipment are stated at cost and are depreciated by the straight-line method for financial reporting purposes and by use of accelerated methods for income tax purposes. Depreciation and amortization of property and equipment are expensed over their estimated useful lives, which are generally 39 years for buildings and three to ten years for equipment. Leasehold improvements and property under capital
leases are amortized over the lesser of the useful life of the asset or the term of the lease. Terms of leases used in the determination of estimated useful lives may include renewal periods at the Company’s discretion when penalty for a failure to renew is so significant that exercise of the option is determined to be reasonably assured at the inception of the lease.
Leases-The Company categorizes leases at inception as either operating leases or capital leases. The Company records rent liabilities for contingent percentage of sales lease provisions when it is determined that it is probable that the specified levels will be reached as defined by the lease. Lease expense for operating leases with increasing rate rents is recognized on a straight-line basis over the term of the lease.
Deferred Financing Costs-Deferred financing costs and original issue discounts are amortized over the life of the related debt using the effective interest rate method.
Interest Rate Risk Management-In August 2013, the Company entered into two one-year forward starting interest rate swaps. The Company accounts for derivatives in accordance with the provisions of FASB ASC Topic 815 “Derivatives and Hedging” (“ASC 815”), which requires companies to recognize all of its derivative instruments as either an asset or liability in the balance sheet at fair value.
Long-Lived Assets-Long-lived assets are reviewed for potential impairment when events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Recoverability of assets to be held and used is measured by comparison of the carrying value of such assets to the undiscounted future cash flows expected to be generated by the assets. If the carrying value of an asset exceeds its estimated undiscounted future cash flows, an impairment provision is recognized to the extent that the carrying amount of the asset exceeds its fair value. The Company considers factors such as current results, trends and future prospects, current market value, and other economic and regulatory factors in performing these analyses. Except for the assets at the Company’s Stevens Point Warehouse as explained in Note 6, the Company determined that no long-lived assets were impaired in Fiscal 2012, Fiscal 2013 and Fiscal 2014, other than goodwill in Fiscal 2012 and Fiscal 2014 as described below.
Customer Lists-Customer lists, which represent prescription files from acquired pharmacies, are amortized over the estimated payback period on acquisition of the files and subject to review for potential impairment when events or changes in circumstances indicate the carrying amount may not be recoverable.
Goodwill-Goodwill represents the excess of cost over the fair value of net assets of businesses acquired. The carrying value of goodwill is evaluated for impairment annually on the first day of the third quarter or whenever events occur or circumstances change that would more likely than not reduce the fair value of the Company’s reporting unit below its carrying amount.
For Fiscal 2012 and Fiscal 2013, the Company determined that it had one financial reporting unit. During the third quarter of Fiscal 2014, the Company reassessed its determination of reporting units based upon the exit from the Minneapolis/St. Paul market, the continued growth of the Mariano’s banner and its management operating structure and determined that it has two financial reporting units. The two financial reporting units identified by the Company during Fiscal 2014 are related to the Company’s business in Wisconsin comprised of the Pick ’n Save, Copps and Metro Market banners and the Company’s business in Illinois comprised of the Mariano’s banner.
The fair value of each reporting unit of the Company is determined by using an income approach based on the discounted cash flows of the reporting unit and a market approach based on comparable market values of the reporting unit, which are considered Level 3 inputs. Projected future cash flows are based on management’s knowledge of the current operating environment and expectations for the future. If the fair value of any reporting unit is less than its carrying amount, the fair value of the implied goodwill is calculated as the difference between
the fair value of the reporting unit and the fair value of the underlying assets and liabilities, excluding goodwill. An impairment charge is recorded for any excess of the carrying amount of goodwill over the implied fair value for each reporting unit.
The Company completed its annual impairment reviews for Fiscal 2012 and Fiscal 2013 and concluded there was no impairment of goodwill. During the fourth quarter of Fiscal 2012, the Company’s market capitalization experienced a significant decline. As a result, management believed that there were circumstances evident which indicated that the fair value of the Company’s reporting unit could be below its carrying amount and management therefore updated its annual review of goodwill for impairment that had been completed as of the first day of the third quarter. With the assistance of a third party valuation firm, the Company completed the first step of the impairment evaluation process in comparing the fair value of its reporting unit to its carrying value. At that time the carrying value exceeded the fair value of the Company’s reporting unit and therefore, the Company completed the second step of the impairment evaluation. The second step calculates the implied fair value of the goodwill, which is compared to the carrying value of goodwill. The implied fair value of goodwill is calculated by valuing all of the tangible and intangible assets of the reporting unit at the hypothetical fair value, assuming the reporting unit had been acquired in a business combination. The excess fair value of the entire reporting unit over the fair value of its identifiable assets and liabilities is the implied fair value of the goodwill. Based upon the calculation of the implied fair value of goodwill, it was determined that the carrying value of the goodwill exceeded the implied fair value of goodwill, which resulted in a non-cash, pre-tax impairment charge of $120.8 million ($106.4 million, net of taxes) during the fourth quarter of 2012.
In accordance with the Company’s policy, the Company qualitatively assessed its goodwill balance in its two reporting units for indicators of impairment as of the first day of the third quarter of Fiscal 2014. During the third quarter of Fiscal 2014, the Company’s market capitalization experienced a sustained significant decline. As a result, management concluded that there were circumstances evident which indicated that the fair value of the Company’s reporting units could be below their carrying amounts. With the assistance of a third party valuation firm, the Company completed the first step of the impairment evaluation process in comparing the fair value of its reporting units to their carrying value. At that time the carrying value exceeded the fair value of our financial reporting units and therefore, the Company completed the second step of the impairment evaluation. Based upon the calculation of the implied fair value of goodwill, it was determined that the carrying value of the goodwill exceeded the implied fair value of goodwill, which resulted in a non-cash, pre-tax impairment charge of $280.0 million ($247.1 million, net of income taxes) during the third quarter of Fiscal 2014.
The testing for impairment of goodwill requires the extensive use of management judgment and financial estimates including weighted average cost of capital, future revenue, profitability, cash flows and fair values of assets and liabilities.
The change in the net carrying amount of goodwill consisted of the following (in thousands):
In connection with the sale of the Rainbow stores, the Company allocated $32.6 million of goodwill to discontinued operations. As of January 3, 2015, the goodwill has been written off and included as part of the gain on the sale of the 18 Rainbow stores. Amounts included in the rollforward have been adjusted to show this reclassification to discontinued operations.
As of January 3, 2015, the Company had goodwill of approximately $297.5 million, of which $173.0 million is related to the Wisconsin financial reporting unit and $124.5 million is related to the Illinois financial reporting unit.
The adjustment to acquisition liabilities relates to closed facility reserves that were established during purchase accounting from prior acquisitions. This adjustment represents the reduction in reserve from the original estimate at the time the facilities were acquired. As these reserves were recognized in accordance with EITF 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination,” any subsequent adjustments are recognized as an adjustment to goodwill.
Trademarks-Trademarks, which have indefinite lives, are not amortized but are evaluated annually for impairment. The review consists of comparing the estimated fair value to the carrying value. Fair value of the Company’s trade names is determined primarily by discounting an assumed royalty value applied to management’s estimate of projected future revenues associated with the trade name. The royalty cash flows are discounted using rates based on the weighted average cost of capital. There was no impairment in Fiscal 2012, Fiscal 2013 or Fiscal 2014.
Self-Insurance- During Fiscal 2013, the Company was self-insured for potential liabilities for workers’ compensation, general liability and employee pharmacy prescriptions. In Fiscal 2012 and Fiscal 2014, the Company was also self-insured for employee health care benefits. It is the Company’s policy to record the liability based on claims filed and a consideration of historical claims experience, demographic factors and other actuarial assumptions for those claims incurred but not yet reported. Any projection of losses concerning these claims is subject to a considerable degree of variability. Among the causes of this variability are unpredictable external factors affecting future inflation rates, litigation trends, legal interpretations, benefit level changes and claim settlement patterns. A summary of the changes in the Company’s self-insurance liability is as follows (in thousands):
Closed Facilities Reserve-When a facility is closed, the remaining net book value of the property, net of expected salvage value, is charged to operations. For properties under lease agreements, the present value of any remaining future liability under the lease, net of estimated sublease income, is expensed at the time the use of the property is discontinued and is classified as operating and administrative expense. The liabilities for leases of closed facilities are paid over the remaining lease term. Adjustments to closed facility reserves primarily relate to changes in sublease income or actual costs differing from original estimates, and are recognized in the period in which the adjustments become known.
The following table provides the activity in the liability for closed stores (in thousands):
Concentrations of Risk-Certain of the Company’s employees are covered by collective bargaining agreements. As of January 3, 2015, the Company had 43 union contracts covering approximately 62% of its employees. Of these contracts, none were expired as of January 3, 2015. There are 26 union contracts that expire in 2015. In the aggregate, contracts not yet negotiated or expiring in 2015 cover approximately 13% of the Company’s employees. The remaining 17 contracts expire in 2016 through 2019. The Company believes that its relationships with its employees are good; therefore, it does not anticipate significant difficulty in renegotiating these contracts.
Stock-based Compensation-The Company accounts for stock-based compensation to employees and directors based on the fair value on the date of the grant. Stock-based compensation expense is recognized over the requisite service period of the award, net of an estimated forfeiture rate.
3. OFFERING OF COMMON STOCK
On February 12, 2014, the Company completed a public offering of 10,170,989 shares of its common stock at a price of $7.00 per share, which included 2,948,113 shares sold by Roundy’s and 7,222,876 shares sold by existing shareholders. The Company received approximately $20.6 million in gross proceeds from the offering, or approximately $19.3 million in net proceeds after deducting the underwriting discount and expenses related to the offering. The net proceeds were used for general corporate purposes, including funding working capital and operating expenses as well as capital expenditures related to the eleven Dominick’s stores acquired from Safeway during the fourth quarter of 2013.
4. ACQUISITION
On December 20, 2013, the Company acquired eleven Dominick’s stores from Safeway in a $36 million cash transaction. As a result of the transaction, the Company assumed the operating leases for ten of the stores and a capital lease liability for one store. As of January 3, 2015, the Company has re-opened all of these stores under the Company’s Mariano’s banner. The transaction enables the Company to expand its presence in the Chicago market and accelerate the number of Mariano’s locations, the Company’s growth banner. The Company paid an amount in excess of the fair value of the assets acquired and recorded goodwill of approximately $4.3 million. The amount of goodwill recorded in connection with the transaction is entirely tax deductible over a 15-year period.
The transaction was accounted for as a business combination under Accounting Standards Codification 805 (“ASC 805”). As such, the purchase price was allocated based on a fair value appraisal by a third party valuation firm. The Company considers the inputs used in the fair value calculations of property under capital lease and the favorable lease rights to be Level 2 within the fair value hierarchy. The Company considers the inputs used in the fair value calculations of the equipment, leasehold improvements and customer lists to be Level 3 within the fair value hierarchy.
The purchase price was allocated as follows (in thousands):
The favorable lease rights will be amortized over the lease term of the acquired stores. The customer lists will be amortized over an expected life of 5 years. Other than the capital lease liability assumed, there were no other liabilities recorded assumed in the transaction.
During the third quarter of Fiscal 2014, the Company recognized a net of tax loss of $0.3 million related to the write-off of certain Dominick’s equipment which the Company did not deploy.
5. DISCONTINUED OPERATIONS
During the second quarter of Fiscal 2014, the Company entered into definitive agreements to sell 18 Rainbow stores in the Minneapolis / St. Paul market to a group of local grocery retailers (“Buyers”), including SUPERVALU INC. (“Rainbow Store Sale”). The aggregate sale price for the 18 Rainbow stores was $65 million in cash plus the proceeds from inventory that was sold to the Buyers at the closing of the Rainbow Store Sale. In addition, as part of the transaction, the Buyers assumed the lease obligations and certain multi-employer pension liabilities related to the acquired stores. The total proceeds received from the Rainbow Store Sale were $76.9 million, resulting in an overall gain of $1.7 million.
As a condition to the sale agreement, the Company entered into sublease agreements for four of the 18 Rainbow stores for a five year period. The amount of the sublease rent payments that will be received from the Buyers are less than the minimum lease payments for these stores. The sublease payments are not considered significant to the operations of these stores, and as such, the Company does not have significant continuing cash flows.
In addition, during the second quarter of Fiscal 2014, the Company announced its intention to exit the Minneapolis / St. Paul market entirely. The remaining nine Rainbow stores not included in the Rainbow Store Sale were closed during the third quarter of Fiscal 2014. The Company recorded a non-cash impairment charge of $11.1 million in the third quarter of Fiscal 2014 related to the assets of the nine Rainbow stores that were closed. The Company also recorded a $10.0 million closed facility charge during the third quarter of Fiscal 2014 related principally to the lease agreements for the nine closed store locations.
The Company incurred severance expense of approximately $2.2 million to the employees of the Rainbow stores that were sold or closed during the third quarter of Fiscal 2014.
As a result of the Rainbow Store Sale and the exit from the Minneapolis / St. Paul market, the Company expects to incur a withdrawal liability related to the multi-employer pension plans in which the affected employees participate. The Company recorded a charge of $49.7 million for the estimated multi-employer pension withdrawal liability, which represents the Company’s best estimate absent demand letters from the multi-employer plans. Demand letters from the impacted multi-employer pension plans may be received in 2015, or later and the ultimate withdrawal liability may change from the currently estimated amount. Any future charge will be recorded in the period when the change is identified. The Company expects the liability will be paid out in quarterly installments, which vary by plan, over a period of up to 20 years. The net present value of the liability was determined using a risk free interest rate. During the fourth quarter of Fiscal 2014, we received a preliminary notice from one of the plans, which required us to make the first quarterly installment during the fourth quarter of 2014, and these quarterly installments will continue for 20 years. The amount of the payment was consistent with the Company’s estimates when the initial charge was recorded. The present value of the payments expected to be made within the next twelve months is included within accrued wages and benefits, and the remainder of the liability for the estimated multi-employer pension withdrawal is included within other long-term liabilities of discontinued operations as presented in the table below.
Also in connection with the sale of the 18 Rainbow stores, we have assigned leases and subleases for these stores which expire at various dates through 2026. A remaining potential obligation exists in the event of a default under the assigned leases and subleases by the assignee. The potential obligations would include rent, real estate taxes, common area costs and other sundry expenses. The future minimum lease payments are approximately $38.9 million. We believe the likelihood of a liability related to these assigned leases and subleases is remote.
The Company has accounted for the 27 Rainbow stores that were either included in the Rainbow Store Sale or closed during the third quarter of Fiscal 2014 as discontinued operations. The Consolidated Balance Sheets as of December 28, 2013 and January 3, 2015 and the Consolidated Statements of Operations for Fiscal 2012, Fiscal 2013 and Fiscal 2014 have been reclassified to conform with this presentation.
The Company has included all direct costs and an amount of allocated interest expense (including amortization of deferred financing costs and loss on debt extinguishment charges) for the 27 Rainbow stores within net income
(loss) from discontinued operations. Interest was allocated based on the ratio of the net assets of the 27 Rainbow stores as of the end of the period to the net assets of the total Company. The Company allocated $8.4 million, $6.4 million and $3.8 million of interest to discontinued operations for Fiscal 2012, Fiscal 2013 and Fiscal 2014, respectively.
Net income (loss) from discontinued operations, net of tax, as presented in the Consolidated Statements of Operations for Fiscal 2012, Fiscal 2013 and Fiscal 2014 is as follows (in thousands):
The assets and liabilities of discontinued operations as of December 28, 2013 and January 3, 2015 include the following:
6. STEVENS POINT
On July 1, 2014 the Company announced the closure of its Stevens Point distribution facility (“Stevens Point Warehouse”). As a result of these actions, the Company evaluated the recoverability of this long-lived asset group and recorded a non-cash impairment charge of $5.1 million for the assets at the Stevens Point Warehouse during the second quarter of Fiscal 2014. The fair value of the long-lived asset group was calculated using level 2 market data inputs. At that time, the Stevens Point Warehouse did not meet the criteria of assets held for sale.
The Company consolidated its supply chain operations previously performed at the Stevens Point Warehouse into its Oconomowoc distribution facility and closed the Stevens Point Warehouse during the third quarter of Fiscal 2014. During the fourth quarter of Fiscal 2014, the Company sold the Stevens Point Warehouse, which resulted in a gain of approximately $10.1 million ($6.5 million, net of income taxes).
The Company recorded severance and other one-time charges of $2.0 million related to the closure of the Stevens Point Warehouse during Fiscal 2014. Other one-time charges included costs to transfer inventory and equipment from the Stevens Point Warehouse to the Oconomowoc warehouse, as well as miscellaneous expenses required to prepare the Stevens Point Warehouse for sale.
7. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In July 2013, the FASB issued ASU No. 2013-11, “Income Taxes” (“ASU No. 2013-11”). ASU No. 2013-11 requires companies to present unrecognized tax benefits as a reduction of the deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, if net settlement is required or expected. To the extent that net settlement is not required or expected, the unrecognized tax benefit must be presented as a liability. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exists at the reporting date and should be made presuming disallowance of the tax position at the reporting date. ASU No. 2013-11 was effective for reporting periods beginning after December 15, 2013, and is applied prospectively to all unrecognized tax benefits that exist at the effective date. Because this standard only affects the presentation of unrecognized tax benefits and not the measurement of an unrecognized tax benefit, this standard did not have a material impact on the Company’s consolidated financial statements.
In May 2014, the FASB issues ASU No. 2014-08, “Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity” (“ASU No. 2014-08”). ASU No. 2014-08 changed the criteria for reporting discontinued operations and requires additional disclosures about discontinued operations. ASU No. 2014-08 is effective on a prospective basis for all disposals of components of an entity that occur within annual periods beginning on or after December 15, 2014, and interim periods within those years. The Company has chosen to not adopt ASU No. 2014-08 early for the Rainbow Store Sale transaction and the closure of the remaining nine Rainbow stores, and as such, the Company expects this standard will not have a material impact on its consolidated financial statements.
In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers” (“ASU No. 2014-09”). ASU No. 2014-09 provides guidance for revenue recognition for companies that either enter into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. The core principle of the new guidance is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The new guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. The Company is currently assessing the potential impact of ASU No. 2014-09 on its consolidated financial statements.
8. PROPERTY AND EQUIPMENT AND OTHER ASSETS
Property and equipment, which are recorded at cost, consisted of the following (in thousands):
Depreciation expense from continuing operations for property and equipment, including amortization of property under capital leases was $54.7 million, $53.9 million, and $62.0 million for Fiscal 2012, Fiscal 2013 and Fiscal 2014, respectively.
Other assets, which are recorded at cost, consisted of the following (in thousands):
Amortization expense from continuing operations (including the amortization of deferred financing costs) was $4.5 million, $6.4 million and $5.8 million for Fiscal 2012, Fiscal 2013 and Fiscal 2014, respectively.
Amortization of other assets from continuing operations (including the amortization of deferred financing costs), excluding trademarks which have indefinite lives, will be approximately $5.7 million in 2015, $3.9 million in 2016, $3.7 million in 2017, $3.6 million in 2018 and $2.0 million in 2019 and $8.8 million thereafter. As of January 3, 2015, the weighted average life of the Company’s customer lists is 2.9 years. As of January 3, 2015, the weighted average life of the Company’s favorable lease rights is 16.0 years.
9. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
On March 3, 2014, Roundy’s Supermarkets, Inc. (“RSI”), the wholly owned operating subsidiary of the Company, refinanced its existing credit facilities (the “2014 Refinancing”), and entered into two new credit facilities, a $460 million term loan (the “New Term Facility”) and a $220 million asset-based revolving credit facility (the “New Revolving Facility”, together with the New Term Facility, the “2014 Credit Facilities”). The Company used the proceeds from the New Term Facility, together with existing cash, to repay the Company’s existing term loan, including all accrued interest thereon and related costs, fees and expenses. The New Term Facility was issued with a 2.0% discount, which will be amortized over the seven year term of the New Term Facility. The New Term Facility has a maturity date of March 3, 2021 that will accelerate to September 15, 2020 if our 10.250% Senior Secured Notes due in 2020 (the “2020 Notes”) are not refinanced in full prior to September 15, 2020. The New Revolving Facility has a maturity date of March 3, 2019.
The New Term Facility bears an interest rate, at our option, of (i) adjusted LIBOR (subject to a minimum floor of 1.00%) plus 4.75% or (ii) a base rate plus 3.75%.
Mandatory prepayments under the New Term Facility will be required with (i) 50% of adjusted excess cash flow (which percentage shall be reduced to 25% and to 0% upon achievement of certain leverage ratios); (ii) 100% of the net cash proceeds of assets sales or other non-ordinary course dispositions of certain property by the RSI and its restricted subsidiaries (subject to certain exceptions and reinvestment provisions); and (iii) 100% of the net cash proceeds of issuances, offerings or placements of certain indebtedness not otherwise permitted to be incurred under the New Term Facility credit agreement.
During the fourth quarter of Fiscal 2014, the Company made a $13.0 million prepayment with the net cash proceeds of the sale of its Stevens Point Warehouse.
Borrowings under the New Term Facility are guaranteed, subject to certain exceptions, by the Company and certain of the Company’s direct and indirect, wholly owned domestic restricted subsidiaries and are secured by substantially all the RSI’s and such guarantors’ assets (subject to certain exceptions) on a first-priority basis, except that with respect to New Revolving Facility Priority Collateral (defined below) such assets are secured on a second-priority basis, in each case subject to certain exceptions and to the terms of the First Lien Intercreditor Agreement described below.
The New Revolving Facility bears an interest rate, at the Company’s option, of (i) adjusted LIBOR plus a margin of 1.50%-2.00% per annum or (ii) base rate plus a margin of 0.50% - 1.00% per annum. In either case, the margin is based on RSI’s utilization of the New Revolving Facility. In addition, there is a quarterly fee payable in an amount equal to either 0.25% or 0.375% per annum of the undrawn portion of the New Revolving Facility. The Company may use borrowings under the New Revolving Facility for ongoing working capital and general
corporate purposes and any other use not prohibited by the revolving credit agreement. Borrowing availability under the New Revolving Facility at any time is based on the value of certain eligible inventory, accounts receivable and pharmacy prescription files and is subject to additional reserves and other adjustments.
Borrowings under the New Revolving Facility are guaranteed, subject to certain exceptions, by the Company and certain of the Company’s direct and indirect, wholly owned domestic restricted subsidiaries and are secured by substantially all the RSI’s and such guarantors’ assets (subject to certain exceptions), in the case of certain assets designated as New Revolving Facility priority collateral including accounts, inventory, cash, deposit accounts, certain payment intangibles and other related assets (“New Revolving Facility Priority Collateral”) on a first-priority basis, and on a second-priority basis with respect to other assets, in each case subject to certain exceptions and to the terms of the First Lien Intercreditor Agreement described below.
On March 3, 2014, RSI and the Company entered into a First Lien Intercreditor Agreement (the “First Lien Intercreditor Agreement”), which establishes the relative lien priorities and rights of the secured parties under the New Revolving Facility and the New Term Facility. Pursuant to the First Lien Intercreditor Agreement, the obligations under the New Revolving Facility are secured with a first priority lien on the New Revolving Facility Priority Collateral and a second priority lien on the other assets constituting collateral, and the obligations under the New Term Facility are secured with a second priority lien on the New Revolving Facility Priority Collateral and a first priority lien on all other collateral (in each case, subject to certain exceptions and limitations).
In connection with the 2014 Refinancing, the Company recognized a loss on debt extinguishment of $9.0 million (of which $8.6 million is related to continuing operations), which consisted primarily of the write-off of $4.8 million of previously capitalized financing costs, the $3.6 million write-off of a portion of the unamortized discount on the 2012 Term Loan, and certain fees and expenses of $0.6 million related to the New Term Facility. The Company capitalized $4.1 million and $0.9 million of financing costs related to the New Revolving Facility and New Term Facility, respectively, both of which will be amortized over the term of the respective term of each credit facility.
The terms of the 2014 Credit Facilities contain customary affirmative covenants and are also secured by substantially all of RSI’s tangible and intangible assets. The terms of the 2014 Credit Facilities also contain customary negative covenants, including restrictions on (i) dividends on, and redemptions of, equity interest and other restricted payment; (ii) liens and sale-leaseback transactions; (iii) loans and investments; (iv) guarantees and hedging agreements; (v) the sale, transfer or disposition of assets and businesses; (vi) transactions with affiliates; (vii) negative pledges and restrictions on subsidiary distributions; and (viii) optional payments and modifications of certain debt instruments.
Prior to the 2014 Refinancing, the Company’s long-term debt included a senior credit facility consisting of a $675 million term loan (the ‘‘2012 Term Loan’’) and a $125 million revolving credit facility (the ‘‘2012 Revolving Facility’’ and together with the 2012 Term Loan, the ‘‘2012 Credit Facilities”). Borrowings under the 2012 Credit Facilities bore an interest rate, at the Company’s option, of (i) adjusted LIBOR (subject to a 1.25% floor) plus 4.5% or (ii) an alternate base rate plus 3.5%. During Fiscal 2012, in connection with entrance into the 2012 Credit Facilities, the Company recognized a loss on debt extinguishment of $13.3 million (of which $12.0 million is related to continuing operations), which consisted primarily of the write-off of $4.5 million of previously capitalized financing costs, the write-off of the remaining unamortized discount of $2.1 million on our old second lien loan that was repaid, prepayment premiums on our old first and second lien loans that were repaid of $4.7 million and certain fees and expenses of $2.0 million related to the 2012 Credit Facilities.
On December 9, 2013, RSI amended its credit agreement governing the 2012 Credit Facilities to, among other things, permit the occurrence of the issuance of the 2020 Notes and the second-priority liens securing the 2020 Notes and related obligations and to revise certain financial maintenance and other covenants.
On December 20, 2013, RSI completed the private placement offering of $200 million of 2020 Notes that mature on December 15, 2020. The Company will pay interest at a rate of 10.25% on the 2020 Notes semiannually,
which commenced on June 15, 2014. The 2020 Notes were issued with a 3.01% discount, which will be amortized over the seven year term of the 2020 Notes. The Company capitalized $4.6 million of financing costs related to the issuance of the 2020 Notes which will be also amortized over the seven year term of the 2020 Notes.
The Company used the net proceeds from the issuance of the 2020 Notes to prepay approximately $148 million in principal amount of the Company’s outstanding 2012 Term Loan and to fund the Chicago Stores Acquisition. The Company capitalized $0.6 million related to an amendment fee paid to lenders of the 2012 Credit Facilities. In addition, the Company expensed $3.5 of unamortized loan costs, including $2.0 million of previously capitalized financing costs and $1.5 million of the unamortized discount on the 2012 Term Loan.
The 2020 Notes are unconditionally guaranteed, jointly and severally, on a senior basis, by (i) RSI’s indirect parent company Roundy’s, Inc., (ii) RSI’s direct parent company Roundy’s Acquisition Corp. and (iii) each of RSI’s domestic restricted subsidiaries owned on the date of original issuance of the 2020 Notes, and are secured by a second priority security interest in substantially all of our and the Guarantors’ assets, which security interests rank junior to the security interests in such assets that secure our 2014 Credit Facilities. The 2020 Notes and the guarantees thereof are secured by a second priority lien on substantially all the assets owned by RSI and the guarantors, subject to permitted liens and certain exceptions. These liens are junior in priority to the first-priority liens on the same collateral securing the 2014 Credit Facilities (as well as certain hedging and cash management obligations owed to lenders thereunder or their affiliates) and to certain other permitted liens under the indenture.
At any time prior to December 15, 2016, the Company may redeem up to 35% of the 2020 Notes with the net cash proceeds received by the Company from any equity offering at a price of 110.250% of the principal amount of the 2020 Notes, plus accrued and unpaid interest.
At any time and from time to time on or after December 15, 2016, the Company may redeem the 2020 Notes, in whole or in part, at the following redemption prices (expressed as percentages of the principal amount) plus accrued and unpaid interest:
On January 3, 2015, there were no outstanding borrowings under the Revolving Facility. Outstanding letters of credit, totaling $29.6 million on January 3, 2015, reduce availability under the Revolving Facility.
At January 3, 2015, the Company was in compliance with all financial covenants relating to its indebtedness.
On January 3, 2015, repayment of principal on long-term debt outstanding was as follows (in thousands):
10. DERIVATIVE FINANCIAL INSTRUMENTS
The Company accounts for derivatives in accordance with the provisions of FASB ASC Topic 815 “Derivatives and Hedging” (“ASC 815”). ASC 815 requires companies to recognize all of its derivative instruments as either an asset or liability in the balance sheet at fair value. Changes in the fair value of derivative instruments designated as cash flow hedges, to the extent the hedges are highly effective, are recorded in other comprehensive income, net of tax effects, and are reclassified into earnings in the period in which the hedged transaction affects earnings. Ineffective portions of cash flow hedges, if any, are recognized in current period earnings.
The Company is exposed to market risk from interest rate fluctuations. In order to manage this risk from interest rate fluctuations, on August 27, 2013, the Company entered into two one-year forward starting interest rate swaps, which will mature on August 27, 2016, to hedge cash flows related to interest payments on $75 million notional amount related to its 2012 Term Loan (the “Swap”). The Swap involves the receipt of floating interest rate amounts in exchange for fixed rate interest payments over the duration of the Swap without an exchange of the underlying principal amount. In accordance with ASC 815, the Company has designated the Swap as a cash flow hedge. The Company has not entered into any other hedging instruments.
As of January 3, 2015, the Company has recorded $0.6 million in other liabilities in the Company’s Consolidated Balance Sheet, which represents the fair value of the Swap on that date. As of January 3, 2015, the Company has $0.3 million in accumulated other comprehensive loss in the Company’s Consolidated Balance Sheet, which represents the loss on the effective portion of the Swap, net of tax. The Company reclassifies interest payments on the Swap to earnings as the interest payments are made. The Company does not expect the amount of losses that will be reclassified into earnings over the next twelve months to be material. During Fiscal 2014, amounts reclassified into current period earnings were not material. The fair value of the Swap as of December 28, 2013 was a liability of $0.4 million.
On March 3, 2014, the Company completed the 2014 Refinancing. Due to a change in certain of the critical terms of the New Term Facility, specifically the change in the interest rate floor, a certain portion of the Swap was deemed ineffective for Fiscal 2014. The amount is considered immaterial.
11. EMPLOYEE BENEFIT PLANS
Company-Sponsored Plans
Certain non-union employees are covered by defined benefit pension plans. Prior to January 1, 2005, benefits were based on either years of service and the employee’s highest compensation during five of the most recent ten years of employment or on stated amounts for each year of service. On May 31, 2006, we amended our primary pension plan. As a result of this amendment, no new participants will be added to the plan and current participants will no longer accrue benefits. Employees are still required to meet the vesting requirements of the plan in order to receive benefits.
As of January 3, 2015, the Company had a letter of credit posted in favor of the Pension Benefit Guaranty Corporation in the amount of $10 million.
The benefit obligation and related assets under all plans have been measured as of the end of Fiscal 2013 and Fiscal 2014, the plans’ measurement dates. The following tables set forth pension obligations and plan assets information (in thousands):
As of December 28, 2013, the Company had one plan that was in a funded status. As of January 3, 2015, all of the Company’s plans were underfunded. The projected benefit obligation and fair value of plan assets for plans with projected benefit obligations in excess of the fair value of plan assets were as follows (in thousands):
Amounts recognized in accumulated other comprehensive loss consist of (in thousands):
We expect to amortize $5.0 million of the actuarial loss as a component of net pension cost in 2015.
Net pension expense (income) from continuing operations consists of (in thousands):
The weighted-average assumptions to determine net periodic benefit costs were as follows:
The weighted-average discount rate assumptions used to determine the benefit obligation was 4.64% and 3.76% at December 28, 2013 and January 3, 2015, respectively.
During Fiscal 2014, the Society of Actuaries finalized new mortality tables and a new mortality improvement scale, which reflect improved life expectancies and an expectation that the trend will continue into the future. For the purposes of measuring the benefit obligation as of January 3, 2015, the Company used the RP-2014 mortality tables, projected using the MP-2014 mortality improvement scale. The impact on the projected benefit obligation as of January 3, 2015 due to the adoption of the new mortality tables was an increase of $9.9 million.
For future periods, the expected long-term rate of return on plan assets is 8.25%. The expected return on plan assets is based on the Company’s expectation of long-term average rate of return of capital markets in which the plans invest. The return on plan assets reflects the weighted-average of the expected long-term rates of return for the broad categories of investments held in the plans. The expected long-term rate of return is adjusted when there are fundamental changes in expected returns on the plans’ investments.
We have an administrative committee that oversees the investment of the assets of the plans and has created a target allocation investment policy. The Company’s investment policies employ an approach whereby a mix of equities and fixed income investments are used to maximize the long-term return of plan assets for a prudent level of risk. The investment portfolio primarily contains a diversified blend of equity and fixed-income investments. The Company’s planned allocation range at January 3, 2015 as a percentage of total market value was approximately 60% equity and 40% fixed-income. Equity investments are diversified across domestic and non-domestic stocks, as well as growth, value, and small to large capitalizations. Fixed income investments include corporate and government securities with short-, mid- and long-term maturities with investment grade ratings at the time of purchase. Investment and market risks are measured and monitored on an ongoing basis through regular investment portfolio reviews, annual liability measurement and periodic asset/liability studies. Investment strategies for plan assets measured at fair value include:
•
Fixed Income-Invest primarily in fixed income securities of U.S. and foreign affiliates, including securities issued or guaranteed by the U.S. and non-U.S. governments.
•
Cash Equivalents-Invest primarily in high quality debt instruments, including commercial paper and corporate obligations, securities issued or guaranteed by the U.S. government or its agencies, certificates of deposit, and bankers’ acceptances.
•
Large/Mid/Small Cap Equity-Invest primarily in common stocks and other equity securities of U.S. companies.
•
Allocation Fund-Invest in equities, fixed income and commodities using a risk-balanced approach so that each asset contributes a relatively equal amount of risk.
•
International Equity-Invest primarily in foreign equity securities, located in Europe, Latin America, and Asia.
•
Real Estate-Invest primarily in common stocks and other equity securities of real estate companies, including real estate investment trusts, and real estate operating companies.
•
Emerging Markets Equity-Invest primarily in common stocks of issuers in emerging and developing markets throughout the world, and may include up to 100% of total assets in foreign securities, primarily of companies with high growth potential.
The plans’ assets are held in pooled separate accounts. The fair value of the plans’ assets is primarily based on quoted market prices for the underlying securities or investments. The method by which fair value is determined can impact the valuation of the plans’ assets and therefore our net pension expense (income). The fair values are classified as Level 2 in the fair value hierarchy since the net asset value per share of the pooled separate account itself is not publicly quoted and the values are not dependent on the input of significant judgment or assumptions by management.
The fair value of the Company’s pension plan assets as of December 28, 2013 and January 3, 2015 are as follows (in thousands):
The following benefit payments, which reflect expected future costs, are expected to be paid by the plans during the following fiscal years (in thousands):
We estimate 2015 minimum required contributions to our defined benefit pension plans will be approximately $0.2 million. Due to uncertainties regarding significant assumptions involved in estimating future required contributions to our defined benefit pension plans, such as interest rate levels, the amount and timing of asset returns and the impact of proposed legislation, we are not able to reasonably estimate our future required contributions beyond 2015.
Multi-Employer Plans
The Company contributes to one multi-employer pension plan based on obligations arising from our collective bargaining agreements covering certain supply chain employees. This plan provides retirement benefits to participants based on their service to contributing employers. The benefits are paid from assets held in trust for that purpose. Trustees are appointed by employers and unions. The trustees are responsible for determining the level of benefits to be provided to participants as well as for such matters as the investment of the assets and the administration of the plan.
The risks of participating in multi-employer pension plans are different from the risks of participating in single-employer pension plans in the following respects:
a. Assets contributed to the multi-employer plan by one employer may be used to provide benefits to employees of other participating employers.
b. If a participating employer stops contributing to the plan, the unfunded obligations of the plan allocable to such withdrawing employer may be borne by the remaining participating employers.
c. If the company stops participating in some of its multi-employer pension plans, the Company may be required to pay those plans an amount based on its allocable share of the underfunded status of the plan, referred to as a withdrawal liability.
We contribute to the Central States, Southeast and Southwest Areas Pension Fund (“Central States Plan”) (EIN 36-6044243-001). The collective bargaining agreement with the covered employees expires in September 2016.
The Central States Plan is underfunded as of January 3, 2015.
The following table represents the zone status (as currently defined by the Pension Protection Act of 2006) as of the Central States Plan’s most recent fiscal year-end nearest December 28, 2013 and January 3, 2015:
Total contributions for continuing operations made to the plans in Fiscal 2012, Fiscal 2013, and Fiscal 2014 are as follows (in thousands):
The Company has not made contributions in excess of 5% of total contributions for the Central States Plan for its plan year ended December 31, 2013.
As of its most recent plan year ended December 31, 2013, the Central States Plan had implemented a rehabilitation plan. The Company has no minimum funding requirements and paid no surcharges for the plan year then ended.
We anticipate that our contributions to this plan may increase; however, because we are one of a number of employers contributing to this plan, it is difficult to ascertain what our share of the underfunding would be. If we choose to exit the plan, any adjustment for a withdrawal liability will be recorded when it is probable that a liability exists and can be reasonably determined.
As discussed in Note 5, during Fiscal 2014, the Company exited three multi-employer plans as a result of the Rainbow Store Sale and the exit from the Minneapolis / St. Paul market.
Defined Contribution Plans
We have a defined contribution plan covering substantially all salaried and hourly employees not covered by collective bargaining agreements. We also have a defined contribution plan covering certain hourly employees covered by a number of collective bargaining agreements. Total expense for our defined contribution plans from continuing operations was $5.5 million, $5.2 million and $6.2 million for Fiscal 2012, Fiscal 2013 and Fiscal 2014, respectively.
12. INCOME TAXES
The provision for income taxes consisted of the following (in thousands):
Federal income tax at the statutory rate of 35% for Fiscal 2012, Fiscal 2013 and Fiscal 2014 and income tax expense as reported are reconciled as follows (in thousands):
The amount included within other income tax expense for Fiscal 2013 and Fiscal 2014 is comprised primarily of settlements of certain state and federal tax audit matters.
The approximate tax effects of temporary differences for continuing operations as of December 28, 2013 and January 3, 2015 are as follows (in thousands):
As of January 3, 2015, the Company has state tax net operating loss carry forwards of approximately $12.8 million, which are due to expire beginning 2031.
The Company files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal or state tax audits for years before 2013. The Company has state tax net operating loss carry forwards which are open for review from 2002 and subsequent years.
A reconciliation of beginning and ending amount of unrecognized tax benefits for continuing operations is as follows (in thousands):
The total amount of tax benefits from continuing operations that, if recognized, would impact the effective tax rate was $0.3 million and $2.8 million (net of tax) at December 29, 2012 and December 28, 2013. There were no tax benefits from continuing operations that, if recognized, would impact the effective tax rate at January 3, 2015. The Company’s policy is to recognize interest and penalties related to income tax matters in the provision for income taxes.
During Fiscal 2012, Fiscal 2013, and Fiscal 2014, the Company recognized $0.2 million, $1.0 million, and $0.2 million respectively, in interest and penalties from continuing operations. The Company accrued $1.1 million for the payment of interest and penalties from continuing operations at December 28, 2013. The Company has accrued an immaterial amount for the payment of interest and penalties from continuing operations at January 3, 2015.
Although timing of the resolution of federal and state income tax audits is highly uncertain, as of January 3, 2015, the Company believes that the amount of unrecognized tax benefits which is reasonably possible to be settled within the next 12 months, including interest and penalties, is approximately $0.3 million.
13. LEASE OBLIGATIONS AND CONTINGENT LIABILITIES
Rent expense and related sublease income from continuing operations under operating leases are as follows (in thousands):
In addition, many of the store leases obligate us to pay real estate taxes, insurance and maintenance costs, and contain multiple renewal options, exercisable at our option, that generally range from one additional five-year period to four additional five-year periods. Those items are not included in the rent expense listed above.
Contingent rentals may be paid under certain store leases on the basis of the store’s sales in excess of stipulated amounts.
Future minimum rental payments under non-cancellable long-term leases from continuing operations, assuming the exercise of certain lease extension options, and future minimum sublease rental income, are as follows at January 3, 2015 (in thousands):
A liability of approximately $7.3 million related to the operating lease commitments disclosed above has been recorded in the closed facility reserve at January 3, 2015.
Sublease income primarily includes payments to be received from third party subtenants at our retail store locations.
In connection with the exit or sale of our independent distribution business in prior years, we have assigned leases and subleases for retail stores which expire at various dates through 2037. A remaining potential obligation exists in the event of a default under the assigned leases and subleases by the assignee. The potential obligations would include rent, real estate taxes, common area costs and other sundry expenses. The future minimum lease payments are approximately $23.8 million for continuing operations. We believe the likelihood of a liability related to these assigned leases and subleases is remote.
Assets under capital leases from continuing operations, consisting of retail store sites, had a net book value of $10.7 million, net of accumulated amortization of $7.4 million, at December 28, 2013 and $10.1 million, net of accumulated amortization of $8.1 million, at January 3, 2015.
We are involved in various claims and litigation arising in the normal course of business. In the opinion of management, the ultimate resolution of these actions will not materially affect our consolidated financial position, results of operations or cash flows.
14. ACCUMULATED OTHER COMPREHENSIVE LOSS
The Company’s accumulated other comprehensive loss is comprised of the adjustments for employee benefit plans and derivatives. During Fiscal 2014, the amount reclassified from accumulated other comprehensive loss was comprised of the net amortization of actuarial losses on employee benefit plans and the net fair value of derivatives. During Fiscal 2014, pension income is included within operating and administrative expenses in the Company’s Consolidated Statement of Operations. During Fiscal 2014, amounts reclassified from accumulated other comprehensive income related to derivatives is included within interest expense in the Company’s Consolidated Statement of Operations.
The change in accumulated other comprehensive loss by component for Fiscal 2013 consisted of the following (in thousands):
The change in accumulated other comprehensive loss by component for Fiscal 2014 consisted of the following (in thousands):
15. EARNINGS PER SHARE
The Company had one class of common stock as of January 3, 2015. Prior to the conversion of our preferred stock to common stock in January 2012, the preferred stock was a participating stock security requiring the use of the two-class method for the computation of basic net earnings per share in accordance with the provisions of ASC 260-10, “Earnings per Share”. Until the liquidation value and unpaid dividends on preferred stock were paid in 2010, the preferred shareholders received first preference to all dividends. Once the unpaid dividends and liquidation value were paid, the preferred stock ceased to accrue dividends and the preferred and common shareholders were entitled to receive a pro-rata share of any future distributions.
Preferred stock was convertible on a one-to-one conversion ratio into common stock and these shares are included in the diluted weighted average common shares outstanding.
Basic earnings per share excludes the effect of common stock equivalents and is computed using the two-class computation method, which excludes earnings attributable to the preferred stock preferential payments from total earnings available to common shareholders. Until the liquidation value and unpaid dividends were paid to the preferred shareholders, the common stock shareholders did not share in net income, unless earnings exceeded the remaining unpaid dividends and liquidation value.
For Fiscal 2012, 2013 and 2014, respectively, there were restricted shares outstanding of approximately 583,000 shares, 6,643 shares and 346,296 shares, respectively, that were excluded because their inclusion would have had an anti-dilutive effect on earnings per share.
As of December 28, 2013, there were 385,183 contingently issuable shares excluded because their issuance was not considered probable. As of January 3, 2015, there were 826,760 contingently issuable shares excluded because their issuance was not considered probable.
The following table reflects the calculation of basic and diluted net earnings (loss) per share for Fiscal 2012, 2013, and 2014 (in thousands, except per share amounts):
16. SHARE-BASED COMPENSATION
The Company’s 2012 Incentive Compensation Plan (the “Plan”) provides for grants of stock options, stock appreciation rights, restricted stock, other stock-based awards and other cash-based awards. An aggregate of 5,656,563 shares of common stock was registered for issuance under the Plan. As of January 3, 2015, there were 2,922,288 remaining shares available for issuance, which assumes that all of the 2014 restricted stock unit grants discussed below vest at the maximum amount.
The Company accounts for share-based compensation awards in accordance with the provisions of FASB ASC Topic 718, “Compensation-Stock Compensation” which requires companies to estimate the fair value of share-based payment awards on the date of grant. The value of the portion of the awards ultimately expected to vest is recognized as expense over the requisite service period. The Company recognized total stock-based compensation of $1.4 million in Fiscal 2012, $2.8 million in Fiscal 2013 and $3.9 million in Fiscal 2014. The Company recognized no tax benefits related to stock-based compensation in Fiscal 2012, $0.9 million in Fiscal 2013 and $1.0 million of tax benefits related to stock compensation in Fiscal 2014. The Company paid no dividends on restricted stock in Fiscal 2012, $0.1 million of dividends on restricted stock shares that vested during Fiscal 2013, and $0.2 million of dividends on restricted stock during Fiscal 2014.
The Company has granted restricted stock to certain employees, as well as to non-employee directors, under the Plan. The service-based restricted stock that was granted to employees in 2012 vests over five years. The service-based restricted stock granted to non-employee directors in 2012, 2013 and 2014 vests over one year.
During the second quarter of 2013, the Company granted 770,366 shares of restricted stock that will vest upon the achievement of certain market performance metrics (the “2013 Market Awards”) and 452,725 shares of stock (the “2013 Time-Based Awards”) that will vest based upon the passage of time, in each case to certain employees and non-employee directors under the Plan. The 2013 Time-Based restricted stock vests ratably over three years for employees from the date of the grant. The 2013 Market Awards will vest after three years if certain specified market conditions are met. The market-based condition is a comparison of the total shareholder return (“TSR”) of the Company’s stock with the TSR of its peer group over the corresponding three year period as determined by the Compensation Committee of the Company’s Board of Directors. These 2013 Market Awards also include a modifier based on the performance of the Company’s operating income as compared to its peer group. The number of shares ultimately vesting will be determined based on the TSR metric and operating income results at the conclusion of the third year. The fair value of the 2013 Market Awards was determined to be $3.02, which was determined using a Monte Carlo simulation model, which utilizes multiple input variables to determine the probability of the Company meeting the market based condition. These inputs include a stock price volatility assumption that is the weighted average between the Company’s volatility since the IPO and the peer group average volatility for the 1.5 year period prior to the Company’s IPO and a 2.7 year risk-free interest rate of 0.33%. The fair value of the 2013 Time-Based Awards was determined based on the stock price as of the date of the grant.
The unvested restricted shares granted under the Plan generally have all the rights of a stockholder, including the right to receive dividends and the right to vote the shares. All of the unvested restricted stock vests upon certain changes of control of the Company.
The change in the number of restricted stock shares outstanding consisted of the following:
During the first quarter of 2014, the Company granted 990,540 restricted stock units that will convert to common stock upon vesting. Of the total units granted, 543,180 units will vest based upon the passage of time (the “2014 Time-Based Awards”), 212,175 units (with a maximum of 424,350 shares of common stock issuable) will vest based upon certain market performance metrics related to TSR (the “2014 Market Awards”) and 235,185 units (with a maximum of 470,370 shares of common stock issuable) will vest based upon certain operating income performance metrics (the “2014 Performance Awards”). The 2014 Time-Based Awards vest over three years for employees and one year for non-employee directors. The 2014 Market Awards will vest after three years if certain specified market conditions are met based on the TSR performance of the Company as compared to a peer group. The number of 2014 Market Awards that will ultimately convert from units to shares will be determined based on the TSR metric at the conclusion of the third year and could be up to 200% of the number of units originally granted. The 2014 Performance Awards will vest after three years if certain operating income performance metrics of the Company are met during Fiscal 2014. The number of 2014 Performance Awards that will ultimately convert from units to shares will be determined based on the operating income performance metrics during Fiscal 2014 and vest at the conclusion of the third year and could be up to 200% of the number of units originally granted. The fair value of the 2014 Market Awards was determined to be $6.85 per unit (or $3.43 per share for the maximum 424,350 shares of common stock issuable), which was determined using a Monte Carlo simulation model, which utilizes multiple input variables to determine the probability of the Company meeting the market based condition. These inputs include a stock price volatility assumption that is the weighted average between the Company’s volatility over the 2.1 years following the IPO and the peer group average volatility for the 0.7 year period prior to the IPO and a 2.8 year risk-free interest rate of 0.82%. The fair value of the 2014 Time-Based and 2014 Performance Awards was determined based on the stock price as of the date of the grant.
The change in the number of restricted stock units outstanding consisted of the following:
(1) Represents the number of restricted units granted. For the 2014 Market Awards and the 2014 Performance Awards, actual shares issued could be up to 200% of the units granted.
As of December 28, 2013, there was $7.5 million of unrecognized compensation expense related to unvested restricted stock awards granted under the 2012 Incentive Compensation Plan. As of January 3, 2015, there was $6.8 million of unrecognized compensation expense related to unvested restricted stock awards granted under the 2012 Incentive Compensation Plan. The expense is expected to be recognized over a weighted-average period of approximately 1.9 years. The intrinsic value of these unvested restricted stock awards is approximately $9.2 million as of January 3, 2015.
17. BUSINESS SEGMENTS
The Company has determined that it has one reportable segment. The Company’s revenues are derived predominantly from the sale of food and non-food products at its stores. Non-perishable categories consist of traditional grocery, frozen and dairy products. Perishable food categories include meat, seafood, produce, deli, bakery and floral. Non-food categories include general merchandise, health and beauty care, pharmacy and alcohol.
The following is a summary of the percentage of sales from continuing operations of non-perishable, perishable, and non-food items for Fiscal 2012, Fiscal 2013, and Fiscal 2014:
18. QUARTERLY INFORMATION (Unaudited)
The summarized quarterly financial data presented below reflect all adjustments, which in the opinion of management, are of a normal and recurring nature necessary to present fairly the results of operations for the periods presented (Annual amounts may not sum due to rounding. In thousands, except for per share amounts).
Fiscal 2013
Fiscal 2014
19. CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS (UNAUDITED)
Under the 2014 Credit Facilities, all obligations of the Company’s principal operating subsidiary, RSI, are secured by a lien on substantially all of the assets of RSI. The 2014 Credit Facilities contain various covenants, including operating performance, ability to incur additional indebtedness, create liens, make certain investments, pay dividends, sell assets, or enter into a merger or acquisition. With respect to dividends, the 2014 Credit Facilities prohibited RSI, subject to certain limited exceptions, from paying dividends or making distributions to Roundy’s.
The following condensed financial statements present Roundy’s financial position as of December 28, 2013 and January 3, 2015 and its results of operations and cash flows for each of the three years in the period ended January 3, 2015 on a parent company-only basis.
In the parent company-only financial statements, Roundy’s investment in its sole direct subsidiary is stated at cost plus equity in undistributed earnings of the subsidiary since the date of formation. Roundy’s share of income is recorded as equity in net income of the unconsolidated subsidiary. The parent company only financial statements should be read in conjunction with Roundy’s consolidated financial statements.
(In thousands)
Roundy’s, Inc.
Consolidated Statements of Comprehensive Income (Loss)
(In thousands)
Roundy’s, Inc.
Consolidated Balance Sheet
(In thousands)
Roundy’s, Inc.
Consolidated Statements of Cash Flows
(In thousands)
ITEM 9
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A
ITEM 9A - CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934 (“Exchange Act”), the Chief Executive Officer and the Chief Financial Officer, together with a disclosure review committee appointed by the Chief Executive Officer, evaluated Roundy’s disclosure controls and procedures as of January 3, 2015, the end of the period covered by this report. Based on that evaluation, Roundy’s Chief Executive Officer and Chief Financial Officer concluded that Roundy’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) were effective as of the end of the period covered by this report to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act, as amended. Under the supervision of management and with the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of January 3, 2015 based on the framework in Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework). Based on our evaluation, we concluded that our internal control over financial reporting was effective as of January 3, 2015.
The effectiveness of the Company’s internal control over financial reporting as of January 3, 2015, has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report, which can be found in Item 8 of this Form 10-K.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B
ITEM 9B - OTHER INFORMATION
None.
PART III
ITEM 10
ITEM 10 - DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Code of Ethics for Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer-We have adopted a Code of Business Conduct which applies to our chief executive officer, chief financial officer and all of our other employees, and which can be found through our website, www.roundys.com under the “Investor Relations” section. Any amendments or waivers to the Code of Business Conduct applicable to our chief executive officer, chief financial officer or chief accounting officer may also be found through our website, www.roundys.com under the “Investor Relations” section.
The information required by Item 401 of Regulation S-K will be included under the captions “Election of Directors” and “Directors and Executive Officers” in the Company’s definitive Proxy Statement for the 2015 Annual Meeting of Stockholders (“Proxy Statement”) to be held May 15, 2015, which section is incorporated in this item by reference. The information required by Items 405, 407(d)(4) and 407(d)(5) of Regulation S-K will be included under the captions “Stock Ownership Information-Section 16(a) Beneficial Ownership Reporting Compliance” and “Corporate Governance” in the Proxy Statement, which sections are incorporated in this item by reference.
ITEM 11
ITEM 11 - EXECUTIVE COMPENSATION
The information required by Item 402 of Regulation S-K will be included under the captions “Executive Compensation” and “Director Compensation” in the Proxy Statement, which section is incorporated in this item by reference. The information required by Item 407(e)(4) of Regulation S-K will be included under the caption “Compensation Committee Interlocks and Insider Participation” in the Proxy Statement, which section is incorporated in this item by reference.
The information required by Item 407(e)(5) of Regulation S-K will be included under the caption “Compensation Committee Report” in the Proxy Statement, which section is incorporated in this item by reference; however, such information is only “furnished” hereunder and not deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934.
ITEM 12
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item will appear under the headings “Stock Ownership Information” in our Proxy Statement, which section is incorporated in this item by reference.
The information required by Item 201(d) of Regulation S-K will be included under the caption “Stock Ownership Information” in our Proxy Statement, which section is incorporated in this item by reference.
The information required by Item 403 of Regulation S-K will be included under the caption “Stock Ownership Information” in our Proxy Statement, which section is incorporated in this item by reference.
ITEM 13
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by Item 404 of Regulation S-K will be included under the caption “Related Person Transactions” in our Proxy Statement, which sections are incorporated in this item by reference.
The information required by Item 407(a) of Regulation S-K will be included under the caption “Director Independence” in our Proxy Statement, which sections are incorporated in this item by reference.
ITEM 14
ITEM 14 - PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item will appear under the heading “Ratification of Selection of Independent Registered Public
Accounting Firm (Proposal No. 2)” in our Proxy Statement, which section is incorporated in this item by reference.
PART IV
ITEM 15
ITEM 15 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES
1. The following financial statements are included in Part II, Item 8 - Financial Statements and Supplementary Data and are incorporated herein by reference:
Consolidated Balance Sheets, December 28, 2013 and January 3, 2015
For the Fiscal Years Ended December 29, 2012, December 28, 2013 and January 3, 2015:
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Income (Loss)
Consolidated Statements of Cash Flows
Consolidated Statements of Shareholders’ Equity
2. Financial Statement Schedules:
Schedule II-Valuation and Qualifying Accounts: The following table displays changes in our valuation accounts:
All other schedules are omitted since the required information is not present.
3. Exhibits
Refer to the Exhibit Index incorporated herein by reference. Each management contract or compensatory plan or arrangement required to be filed as an exhibit to this report is identified in the Exhibit Index by an asterisk following the Exhibit Number.
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on March 13, 2015.
/S/ ROBERT A. MARIANO
Robert A. Mariano
Chairman, President and Chief Executive Officer
and Director (Principal Executive Officer)
/S/ MICHAEL P. TURZENSKI Michael P. Turzenski
Group Vice President and Chief Financial Officer
(Principal Financial Officer)
*
Patrick J. Condon
Director
* Christopher F. Larson
Director
*
Ralph W. Drayer
Director
* Avy H. Stein
Director
*
Gregory P. Josefowicz
Director
EXHIBIT INDEX
* Denotes a management contract or compensatory plan.