Item 1B.
Unresolved Staff Comments
None
We own our corporate offices and Distribution Center located at Norton. The following schedule presents the square footage by major classification within our corporate offices and Distribution Center as of September 26, 2010.
As of September 26, 2010, we owned 48 of our supermarkets and leased the remaining 119 supermarkets. We believe our supermarkets are well maintained and adequately meet the expectations of our customers. We operate 167 supermarkets in the Southern California counties of San Bernardino, Riverside, Orange, Los Angeles, San Diego and Kern. The following schedule reflects our store count by size and county, and the number of stores that were either leased or owned by us as of September 26, 2010.
The total square footage of our supermarkets is approximately 5.8 million square feet, of which approximately 4.1 million square feet is selling area.
In the ordinary course of business, we are party to various legal actions which we believe are incidental to the operation of our business and the business of our subsidiaries. We record an appropriate provision when the occurrence of loss is probable and can be reasonably estimated. We believe that the outcome of such legal proceedings to which we are currently a party will not have a material adverse effect upon our results of operations or our consolidated financial condition.
In December 2008, an action by Dennis M. O’Connor, et al. was filed in the Los Angeles Superior Court against Santee Dairies, Inc., dba Heartland Farms (now SBM Dairies, Inc.) seeking individual and potential class action monetary damages for time spent by non-exempt hourly paid employees for changing into and out of sanitary uniforms. On September 23, 2010, following mediation the case was settled. Under the settlement agreement, the settlement amount will be paid pursuant to procedures for filing and approval of claims for members of the certified class with a portion of any unclaimed amounts returned to SBM Dairies, Inc. The full settlement amount has been recorded in our consolidated financial statements.
Item 4.
Submission of Matters to a Vote of Security Holders
None
PART II
Item 5.
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
(a) Market Information
There is no established public trading market for Holdings’ common equity.
(b) Holders
La Cadena holds 34,552 shares, or 100% of Holdings’ outstanding Class A Common Stock.
(c) Dividends
As of September 26, 2010, we had the ability and right to pay restricted payments, including dividends, of up to $38.0 million.
Dividends of $5.0 million were paid in each of the fiscal years of 2010 and 2008.
The following table sets forth historical financial data derived from the audited consolidated financial statements of Holdings as of and for the fiscal years ended September 24, 2006, September 30, 2007, September 28, 2008, September 27, 2009 and September 26, 2010. The information set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Audited Consolidated Financial Statements and related notes thereto contained elsewhere herein. The information included in “Other Operating and Financial Data” and “Store Data” is unaudited.
Item 6.
Selected Financial Data (contd.)
(1)
Certain balance sheet and corresponding cash flow line items for prior periods have been reclassified to conform with current presentation related to the Dairy Transaction and the presentation of such assets and liabilities as held for sale.
(footnotes continued on following page)
Item 6.
Selected Financial Data (contd.)
(2)
We calculate like store sales by comparing year-to-year sales for stores that are opened in both years. For stores that were not opened for the entire previous year, we only use the current year’s weekly sales that correspond to the weeks the stores were open in the previous year. For replacement store sales, we include sales for the entire year in the like store sales calculation. For stores that were closed during the year, we only include prior year sales that correspond to the week the stores were opened in the current year.
(3)
Fixed charge coverage ratio is calculated based on definitions from the indentures to our Senior Notes. Exhibit 12.1 included in this Form 10-K shows the calculation of the fixed charge coverage ratio.
(4)
Average sales per store, sales per total square feet and sales per selling square feet are calculated by prorating the number of stores, total square feet and selling square feet by the period of time the store was opened, for new stores, or the period of time the expanded square footage was in service, for expanded stores.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Critical Accounting Policies
Our discussion and analysis of financial condition and results of operations are based upon our Audited Consolidated Financial Statements prepared in accordance with U.S. generally accepted accounting principles. The preparation of the financial statements requires the use of estimates and judgments on the part of management. We base our estimates on our historical experience combined with our understanding of current facts and circumstances. We believe that the following critical accounting policies are the most important to our financial statement presentation and require the most difficult, subjective and complex judgments on the part of management.
Self-Insurance Reserves
We are primarily self-insured, subject to certain retention levels for workers’ compensation, automobile and general liability costs. We are covered by umbrella insurance policies for catastrophic events. We record our self-insurance liability based on claims filed and an estimate of claims incurred but not yet reported. The estimates used by us are based on our historical experiences as well as current facts and circumstances. We use third party actuarial analysis in making our estimates. Actuarial projections and our estimate of ultimate losses are subject to a high degree of variability. The variability in the projections and estimates are subject to, but not limited to, such factors as judicial and administrative rulings, legislative actions, and changes in compensation benefits structure. We discounted our workers’ compensation, automobile and general liability insurance reserves at a discount rate of 6.25% for fiscal 2008, 5.50% for fiscal 2009 and 5.00% for fiscal 2010. The analysis of self-insurance liability is sensitive to the rate used to discount the anticipated future cash flows for the workers’ compensation, automobile and general liability insurance reserves. For fiscal 2010, if a rate of 4.00% was used to discount the reserves, the reserves for self insurance would have been $1.8 million higher than the reserves calculated at a 5.00% discount rate. If a rate of 6.00% was used in fiscal 2010 to discount the reserves, the reserves for self insurance would have been $1.7 million lower than the reserves calculated at a 5.00% discount rate.
Employee Benefit Plans
The determination of our obligation and expense for pension benefits is dependent, in part, on our selection of certain assumptions used by our actuaries in calculating these amounts. These assumptions are disclosed in “Note 7 - Retirement Plans” in the accompanying Notes to the Audited Consolidated Financial Statements contained herein and include, among other things, the discount rate, the expected long-term rate of return on plan assets and the rate of compensation changes. In accordance with U.S. generally accepted accounting principles, actual results that differ from our assumptions are accumulated and amortized over future periods and, therefore, affect recognized expense and the recorded obligation in such future periods. While we believe our assumptions are appropriate, significant differences in our actual experience or significant changes in the assumptions may materially affect our pension obligations and expense for pension benefits.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (contd.)
Critical Accounting Policies (contd.)
Employee Benefit Plans (contd.)
For fiscal 2010, the discount rate used to calculate the net periodic pension cost was 5.00%. If the rate used to discount the net periodic pension cost was 4.00%, net periodic pension cost would have been $1.0 million higher than the cost calculated at a 5.00% discount rate. If the rate used to calculate the net periodic pension cost was 6.00%, net periodic pension cost would have been $0.8 million lower than the cost calculated at the 5.00% discount rate.
We also contribute to various multi-employer defined contribution retirement plans for all of our employees represented by labor unions. We are required to make contributions to these plans in amounts established under collective bargaining agreements, generally based on the number of hours worked. Pension expenses for these plans are recognized as contributions are funded. While we expect contributions to these plans to continue to increase over time, the amount of increase or decrease will depend upon the outcome of collective bargaining, actions taken by trustees and the actual return on assets held in these plans. For these reasons, it is not practicable for us to determine the amount by which multi-employer pension contributions will increase or decrease.
Income Taxes
We recognize deferred income tax assets and liabilities by applying statutory tax rates in effect at the balance sheet date to differences between the book basis and the tax basis of assets and liabilities. Deferred 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 reverse. Deferred tax assets and liabilities are adjusted to reflect changes in tax laws or rates in the period that includes the enactment date. Significant accounting judgment is required in determining the provision for income taxes and related accruals and deferred tax assets and liabilities. In the ordinary course of business, there are transactions and calculations where the ultimate tax outcome is uncertain. Judgment is needed to determine if the recognition threshold is met to recognize the tax position taken or if a liability is needed to record an unrecognized tax liability. We are subject to periodic audits and examinations by the Internal Revenue Service and other state and local taxing authorities. Although we believe that our estimates are reasonable, actual results could differ from these estimates.
Significant Accounting Policies
In addition to the critical accounting policies disclosed above, there are certain accounting policies that we have adopted that may differ from policies of other companies within the supermarket industry. Such differences in the treatment of these policies may be important to the readers of our Form 10-K and our Audited Consolidated Financial Statements contained herein. For further information regarding our accounting policies, refer to “Note 1 - The Company and Summary of Significant Accounting Policies” in the Notes to the Audited Consolidated Financial Statements contained herein.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (contd.)
Ownership of the Company
La Cadena, a California general partnership whose sole voting partner is the Jack H. Brown Revocable Trust, holds all of our issued and outstanding capital stock. Mr. Jack H. Brown, the Chairman of the Board, President and Chief Executive Officer of Holdings, is the Managing General Partner of La Cadena with the power to vote the shares of our capital stock held by La Cadena on all matters, including with respect to the election of our Board of Directors, and any other matters requiring shareholder approval.
Executive Overview
On October 11, 2009, we sold substantially all of the assets of Dairies to subsidiaries of Dean Foods for $88.0 million in cash and assumption of certain liabilities including substantially all of Dairies’ current liabilities, which included accounts payable. In the second quarter of fiscal 2010, the purchase price was adjusted upwards by approximately $1.5 million due to an adjustment for working capital. Dairies’ assets which were sold consisted primarily of accounts receivable, inventory and property and equipment. Also on October 11, 2009, we entered into the PPA with Dean Foods to purchase substantially all fluid milk products sold in our supermarkets from Dean Foods. The purchase prices under the PPA are deemed to approximate market pricing. We incurred approximately $3.8 million in fees related to the Dairy Transaction and recognized a gain, net of tax, of approximately $5.6 million. We retained responsibility for all workers’ compensation claims of Dairies’ employees for events occurring through the transaction date. As of October 11, 2009, the Company ceased all dairy manufacturing operations.
As a result of the Dairy Transaction and the continued decline in the current economy, our net sales were lower in fiscal 2010 than in fiscal 2009. Our strategy in the near term is to retain customer counts during these tough economic times by continuing to provide exceptional customer service and provide value to our customers on their purchases from our supermarkets.
Our marketing area of Southern California continues to be highly competitive and in flux. With the current economic conditions, our marketing area has seen job losses and business closures which will put further pressure on our gross margin as we endeavor to retain our customer base. For the foreseeable future, we anticipate continued competitive pressures from “big box” format competitors including Walmart, Costco, Target and Winco and from our traditional grocery format competitors Vons, Albertsons and Ralphs and from independent supermarket operators.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (contd.)
Results of Operations
Sales and Gross Profit (in thousands)
Sales
Overall, our sales were down $159.2 million in fiscal 2010 versus fiscal 2009. $93.2 million of the decrease in our sales was due to the lost sales from Dairies as a result of the Dairy Transaction. Sales in our supermarkets decreased $66.0 million primarily due to the continued downturn in the economy in our primary marketing areas.
The increase in fiscal 2009 sales over fiscal 2008 is primarily the result of opening new stores in fiscal 2008 and fiscal 2009.
Like Store Sales
Our like store sales have been adversely affected by the downturn in our local economy and by continued competitive pressures. For the foreseeable future, we anticipate that our like store sales will continue to be challenged as we believe that unemployment in our marketing area will continue to be high and competitive pressures will continue.
We calculate like store sales by comparing year-to-year sales for stores that are opened in both years. For stores that were not opened for the entire previous year periods, we only include the current year’s weekly sales that correspond to the weeks the stores were opened in the previous year. For stores that have been closed, we only include the prior year’s weekly sales that correspond to the weeks the stores were opened in the current year. Replacement store sales and replaced store sales are included in like store sales.
Like store sales are affected by various factors including, but not limited to, inflation and deflation, promotional discounting, customer traffic, buying trends, pricing pressures from competitors and competitive openings and closings.
Like store sales decreased $89.9 million or 2.45% in fiscal 2010 compared to fiscal 2009. Newly opened stores that were not opened for the full year of fiscal 2009 added $25.0 million to our sales in fiscal 2010. We closed a store in fiscal 2009 which reduced fiscal 2010 sales by approximately $1.2 million.
Like store sales increased $1.5 million or 0.04% in fiscal 2009 over fiscal 2008. We opened three new stores and closed one store in fiscal 2009. The new stores opened in fiscal 2009 added approximately $30.5 million to fiscal 2009 sales. In addition, we estimate that a store opened during fiscal 2008 added approximately $8.2 million to fiscal 2009 sales for the weeks it was not opened in fiscal 2008. While the newly opened stores increased sales in fiscal 2009, we estimate that these stores drew approximately $15.9 million of their sales from existing stores. The store closed in fiscal 2009 reduced sales by approximately $12.2 million.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (contd.)
Results of Operations (contd.)
Gross Profit
The increase in our gross profit margin in fiscal 2010 over fiscal 2009 is primarily due to our suspension in November 2009 of a special produce discounting program which we started in June 2009 and continued until November 2009. Also, during the fourth quarter of fiscal 2010, we consciously focused our promotion dollars to specific product categories.
The decrease in gross margin in fiscal 2009 compared to fiscal 2008 is the result of increased competitive pricing pressures in our marketing area and the result of our efforts, in the current economic environment, to keep prices low in order to retain customers.
Operating Expenses and Income (in thousands)
Selling, General and Administrative Expenses
The increase in selling, general and administrative expenses, as a percentage of sales, is attributed primarily to increases, as a percentage of sales, in payroll related costs and to a settlement of an employment related lawsuit for Dairies. Payroll related expenses, as a percentage of sales, increased 0.72% and was primarily comprised of increases of 0.39%, as a percentage of sales, in union insurance benefits and an increase in workers compensation expense, as a percentage of sales, of 0.14% of sales. Union insurance increased approximately $11.6 million over fiscal 2009 primarily as a result of higher insurance rates under our UFCW contracts. Workers’ compensation expense increased approximately $4.2 million over fiscal 2009 due to increases in our self insurance reserves. In fiscal 2010, we settled a lawsuit related to a class action employment claim. See “Item 3
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (contd.)
Results of Operations (contd.)
Gain on Sale of Assets
The pretax gain from the Dairy Transaction was approximately $9.4 million.
Depreciation and Amortization
Depreciation expense was $50.8 million, $53.5 million and $53.0 million in fiscal 2010, 2009 and 2008, respectively. The reduction in depreciation in fiscal 2010 is primarily due to the Dairy Transaction. Included in cost of goods sold is depreciation expense related to our warehousing and distribution activities of $11.3 million, $14.6 million and $14.0 million in fiscal years 2010, 2009 and 2008, respectively. Our fiscal 2009 and 2008 cost of goods sold included depreciation from our dairy operations.
Interest Income
Interest income was $0.4 million, $0.5 million and $5.7 million in fiscal years 2010, 2009 and 2008, respectively. Interest income has decreased year-over-year as the interest rate realized on our short-term investments has decreased.
Interest Expense
Interest expense amounted to $68.5 million, $68.3 million and $57.5 million for the 2010, 2009 and 2008 fiscal years, respectively. Interest capitalized during construction projects, which reduces interest expense, was $0.5 million and $11.3 million in fiscal years 2009 and 2008, respectively. We had no capitalized interest in fiscal 2010 as we didn’t have any new store construction. The change in capitalized interest in fiscal 2009 over fiscal 2008 is primarily attributed to the timing of construction of our corporate offices and Distribution Center.
Income Before Income Taxes
Income before income taxes amounted to $41.2 million, $54.3 million and $66.6 million in fiscal 2010, 2009 and 2008, respectively.
Income Taxes
Income taxes amounted to $16.6 million, $19.5 million and $26.0 million in fiscal 2010, 2009 and 2008, respectively. Our effective tax rate was 40.3%, 35.9% and 39.0% for fiscal years 2010, 2009 and 2008, respectively. The reduced effective tax rate in fiscal 2009 compared to fiscal 2010 and fiscal 2008 was due primarily to a previously unrecognized tax benefit associated with Dairies being able to be taken in fiscal 2009 that was not present in fiscal 2010 and 2008.
Net Income
Net income for fiscal 2010 amounted to $24.6 million, compared to $34.8 million in fiscal 2009 and $40.6 million in fiscal 2008.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (contd.)
Liquidity and Capital Resources
We historically fund our daily cash flow requirements through funds provided by operations. We have the ability to borrow under our short-term revolving credit facility which consists of a revolving loan facility for working capital and letters of credit of $100 million. The letter of credit facility is maintained pursuant to our workers’ compensation and general liability self-insurance requirements.
As of September 26, 2010, we had $49.8 million of outstanding letters of credit and we had $50.2 million available under our credit facility.
We had no short-term borrowings outstanding as of September 26, 2010 and we did not incur any short-term borrowings during fiscal 2010.
Working capital amounted to $206.1 million at September 26, 2010 and $274.4 million at September 27, 2009. Our current ratios were 1.49:1 and 1.94:1 at September 26, 2010 and September 27, 2009, respectively. Our working capital and current ratio were affected in fiscal year 2010 by our decision to early extinguish our $525.0 million Senior Notes due 2012. $132.3 million of our previously classified long-term debt has been classified as current on our September 26, 2010 consolidated balance sheet. Fluctuations in working capital and current ratios are not unusual in our industry.
Net cash provided by operating activities for fiscal 2010 was $87.1 million compared to $122.4 million for fiscal 2009 and $57.5 million for fiscal 2008. Significant sources of cash from operating activities in fiscal 2010 included our net income adjustment for non-cash depreciation and amortization and an increase in accrued liabilities offset in part by a decrease in accounts payable. We received approximately $85.8 million, after fees, from the Dairy Transaction. During fiscal 2010, we expended $33.8 million in capital expenditures.
Significant sources of cash from operating activities in fiscal 2009, included our net income adjustment for non-cash depreciation and amortization, increases in our pension liability and decreases in inventory levels. In fiscal 2009, we recognized $11.5 million, net of tax of $7.9 million, in other comprehensive loss from actual losses in our pension and medical plan benefits. Our inventory levels decreased in fiscal 2009 due to the timing of inventory purchases. During fiscal 2009, we expended $77.0 million in capital expenditures.
We believe that capital expenditures for fiscal 2011 will be approximately $52.3 million and we expect to finance the expenditures from cash on-hand and from cash from operating activities. The following table sets forth the major components of expected fiscal 2011 capital expenditures.
We believe that operating cash flows and current cash reserves will be sufficient to meet our currently identified operating needs and scheduled capital expenditures. However, we may elect to fund some capital expenditures through capital leases, operating leases or debt financing. There can be no assurance that such debt and lease financing will be available to us in the future.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (contd.)
Existing Credit Facility
On May 4, 2010, the Company and Markets entered into the Third Amended and Restated Credit Agreement with Bank of America, N.A. (“Bank of America”), as sole and exclusive administrative agent and sole initial lender, consisting of a three-year unsecured revolving credit facility in a principal amount of up to $100 million (the “Credit Facility”), which replaced the Company’s previous credit facility.
The Credit Facility is guaranteed by all of the Company’s existing and future material subsidiaries, including Development and the Company’s indirect subsidiary Super Rx. Subject to certain restrictions, the entire amount of the Credit Facility may be used for loans, letters of credit, or a combination thereof. Borrowings under the Credit Facility are unsecured and may be used for working capital, certain capital expenditures and other general corporate purposes. Letters of credit issued under the letter of credit facility are expected to be used to support obligations incurred in connection with the construction of stores and workers’ compensation insurance obligations. The availability of the loans and letters of credit is subject to certain borrowing restrictions.
Loans under the Credit Facility bear interest at a rate based upon either (i) the “Base Rate” (defined as the higher of (a) the federal funds rate plus 0.50% and (b) the rate of interest publicly announced by Bank of America as its “prime rate”), plus 1.00%, or (ii) the “Eurodollar Rate” (defined as the British Bankers Association LIBOR Rate for deposits in dollars, adjusted for the maximum reserve requirement for Eurocurrency funding), plus 1.75%. For Eurodollar Rate Loans, the Eurodollar Rate will apply for periods, as selected by the Company, of one, two, three or six months (but in any event not later than the maturity date of the Credit Facility).
The Credit Facility requires the Company to meet certain financial tests, including minimum net worth and the maintenance of minimum earnings levels. The Credit Facility contains covenants which, among other things, limit the ability of the Company and its subsidiaries to (i) incur indebtedness, grant liens and guarantee obligations, (ii) enter into mergers, consolidations, liquidations and dissolutions, asset sales, investments, leases and transactions with affiliates, and (iii) make restricted payments. Markets is not limited in its ability to transfer assets in the form of loans, advances or cash dividends to the Company. The Credit Facility also contains covenants that apply to the Company and its subsidiaries, and the Company is a party to the Credit Facility for purposes of these covenants. These covenants, among other things, limit the ability of the Company and its subsidiaries to incur indebtedness, make restricted payments, enter into transactions with affiliates, and make certain amendments to the Indentures governing the 8.125% Senior Notes and the 7.75% Senior Notes (“Notes Indentures”).
As of September 26, 2010, the Company was in compliance with all restrictive covenants under the Credit Facility. However, there can be no assurance that the Company will be able to achieve the expected operating results or implement the capital expenditure strategy upon which future compliance with such covenants is based.
New Credit Facility
On November 29, 2010, we entered into a new $245 million senior secured credit facility (the “New Credit Facility”) with Bank of America, N.A., as administrative agent and a lender. The New Credit Facility consists of a four-year $145 million term loan (the “Term Loan”) and a $100 million revolving credit facility (the “New Revolving Credit Facility”). The New Credit Facility replaced our existing $100 million credit facility as of November 29, 2010. The New Credit Facility is secured by substantially all of the Company’s personal property excluding certain intangible assets consisting of trademarks and shares of capital stock. The New Credit Facility is guaranteed by the Company, Development, Super Rx and Dairies.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (contd.)
New Credit Facility (contd.)
The Term Loan bears interest at Eurodollar Rate plus 2.50% or the Base rate plus 1.50% (as defined in the New Credit Facility) and the interest is payable quarterly in arrears and includes mandatory quarterly principal payments of 5.0% in each of the first two years of the agreement and 10.0% in years three and four of the agreement. The Term Loan also includes additional mandatory principal payments on the Term Loan based on a percentage of “excess cash flow” as defined in the New Credit Facility”. The Term Loan is due November 29, 2014 with any remaining outstanding principal amounts under the Term Loan due as of that date. The security held under the New Credit Facility is held until the Term Loan is paid in full. We incurred $2.1 million of debt issuance cost related to the Term Loan which will be amortized over the term of the Term Loan.
Subject to certain restrictions, the entire amount of the New Revolving Credit Facility may be used for loans, letters of credit, or a combination thereof. Borrowings under the New Revolving Credit Facility are secured and will be used for working capital, certain capital expenditures and other general corporate purposes. Letters of credit issued under the letter of credit facility are expected to be used for workers’ compensation insurance obligations and may be used for new store construction and certain other corporate purposes. The availability of the loans and letters of credit is subject to certain borrowing restrictions.
Loans under the New Revolving Credit Facility bear interest at a rate based upon either (i) the “Base Rate” (defined as the higher of (a) the federal funds rate plus 0.50% and (b) the Bank of America “prime rate”), plus 1.50%, or (ii) the “Eurodollar Rate” (defined as the British Bankers Association LIBOR Rate adjusted for the maximum reserve requirement for Eurocurrency funding), plus 2.50%. For Eurodollar Rate loans, we will be entitled to select interest periods of one, two, three, six, nine or twelve months, subject to availability.
The loans under the New Revolving Credit Facility may be prepaid at any time without penalty, subject to certain minimums and payment of any breakage and re-deployment costs in the case of loans based on the Eurodollar rate. We may reduce the commitments under the New Revolving Credit Facility. We will be required to pay a commitment fee equal to 0.25% per annum on the actual daily unused portion of the revolving loan facility and the letter of credit facility, payable quarterly in arrears. Outstanding letters of credit under the New Revolving Credit Facility are subject to a fee of 1.25% per annum on the face amount of such letters of credit, payable quarterly in arrears. We will be required to pay standard fees charged by Bank of America with respect to the issuance, negotiation, and amendment of commercial letters of credit issued under the letter of credit facility.
The New Revolving Credit Facility requires us to meet minimum shareholder’s equity and EBITDA tests. The New Revolving Credit Facility contains covenants which, among other things, limit our ability to (i) incur indebtedness, grant liens and guarantee obligations, (ii) enter into mergers, consolidations, liquidations and dissolutions, asset sales, investments, leases and transactions with affiliates, (iii) make restricted payments, (iv) enter into transactions with affiliates and (v) make amendments to the Indenture governing our Senior Notes. Markets and our other subsidiaries are not limited in their ability to transfer assets in the form of loans, advances or cash dividends to us.
The New Revolving Credit Facility contains customary events of default, including payment defaults; material inaccuracies in representations and warranties; covenant defaults; cross-defaults to certain other indebtedness; certain bankruptcy events; certain ERISA events; judgment defaults; invalidity of any guaranty; and change of control.
Our $49.8 million of outstanding letters of credit continue to be issued and outstanding under the New Revolving Credit Facility.
The New Revolving Credit Facility will cease to be available and will be payable in full on November 29, 2014.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (contd.)
Labor Relations
The UFCW’s collective bargaining agreements were renewed in March 2007 and expire in March 2011. The Teamsters’ collective bargaining agreement was renewed in October 2010 and expires in September 2015.
We value our employees and believe our relationship with them is good and that employee loyalty and enthusiasm are key elements of our operating performance.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements, other than stand-by letters of credit, as discussed under the caption “Liquidity and Capital Resources” in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report and operating leases as disclosed in “Note 5 - Leases” in the Notes to the Audited Consolidated Financial Statements contained herein, that would have or are reasonably likely to have material current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (contd.)
Tabular Disclosure of Contractual Cash Obligations
The following table sets forth our contractual cash obligations and commercial commitments as of September 26, 2010.
(1)
The maturity and interest payment shown here on our 8.125% Senior Notes due 2012 (the “Old Notes”) reflects the contractual due date of June 15, 2012. On November 29, 2010, we early redeemed approximately $477.5 million of the Old Notes and on January 14, 2011 we will call all remaining outstanding Old Notes. See “Note 2 - New Debt and Early Extinguishment of Debt” to our Audited Consolidated Financial Statements contained elsewhere herein.
(2)
We lease the majority of our retail stores. We have subleased our former headquarters buildings and certain former distribution facilities located in Colton, California under an initial 15 year term for an amount equal to our lease payments. For purposes of contractual cash obligation shown here, minimum lease payments on this lease are shown without sub-lease offset. Certain of our operating leases provide for minimum annual payments that change over the primary term of the lease. For purposes of contractual cash obligations shown here, contractual step increases or decreases are shown in the period they are due. Certain leases provide for additional rents based on sales. Primary lease terms range from 3 to 55 years and substantially all leases provide for renewal options.
(3)
Letters of credit are committed as security for workers’ compensation. Outstanding letters of credit expire between December 2010 and October 2011. Outstanding letters of credit continue to be issued and outstanding under our New Revolving Credit Facility.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (contd.)
Cautionary Statement
The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Certain information contained in our filings with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by us) includes statements that are forward-looking, such as statements relating to plans for future activities. Such forward-looking information involves important risks and uncertainties that could significantly affect results in the future and, accordingly, such results may differ from those expressed in any forward-looking statements made by or on behalf of Holdings. These risks and uncertainties include, but are not limited to, those relating to domestic economic conditions, seasonal and weather fluctuations, labor unrest, expansion and other activities of competitors, changes in federal or state laws and the administration of such laws and the general condition of the economy.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosure about Market Risk
We are subject to interest rate risk on our fixed interest rate debt obligations. Our fixed rate debt obligations are comprised of the 8.125% Senior Notes, the 7.75% Senior Notes and capital lease obligations. In general, the fair value of fixed rate debt will increase as the market rate of interest decreases and will decrease as the market rate of interest increases. While interest rate changes will impact the market value risk of our bonds, such changes do not affect our earnings or cash flows. The fair values of the 8.125% Senior Notes and the 7.75% Senior Notes are based upon quoted market prices. Although quoted market prices are not readily available on our capital lease obligations, we believe that stated values approximate the fair value of these obligations. We have not engaged in any interest rate swap agreements, derivative financial instruments or other type of financial transactions to manage interest rate risk. The following table provides the future principal cash flows and weighted-average interest rates expected on our fixed rate debt obligations. The fair value shown here is based upon the quoted market price of the 8.125% Senior Notes and the 7.75% Senior Notes and the stated value of our capital leases as of September 26, 2010. The maturity dates and average interest rates below reflect the contractual due date on our 8.125% Senior Notes of June 15, 2012 and does not reflect our early redemption of debt which took place on November 29, 2010 and the expected call of the remaining outstanding balance of our 8.125% Senior Notes on January 14, 2011. See “Note 2 - New Debt Issuance and Early Extinguishment of Debt” to our Audited Consolidated Financial Statements contained elsewhere herein.
Item 8.
Item 8. Financial Statements and Supplementary Data
Information called for by this item is set forth in Holdings’ Audited Consolidated Financial Statements and supplementary data contained in this report. Specific financial statements and supplementary data can be found on the pages listed in the following index.
INDEX TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports 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 our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the costs and benefits of such controls and procedures. Based on that evaluation our Chief Executive Officer and our Chief Financial Officer, we concluded that the Company’s disclosure controls and procedures were effective as of September 26, 2010.
Changes in Internal Controls Over Financial Reporting
During the fourth quarter ended September 26, 2010, there were no changes in our internal control over financial reporting or in other factors that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9A. Controls and Procedures (contd.)
Management’s Report on Internal Control Over financial Reporting
Management of the Company, including our Chief Executive Officer and our Chief Financial Officer, is responsible for the preparation and integrity of the consolidated financial statements appearing in our annual report on Form 10-K. The financial statements were prepared in conformity with generally accepted accounting principles appropriate in the circumstances and, accordingly, include certain amounts based on our best judgments and estimates.
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Our Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. 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.
The Company, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. This evaluation included review of the documentation of controls, evaluation of the design effectiveness of controls, testing of the operating effectiveness of controls and a conclusion on this evaluation.
Based on our assessment, management concluded that the Company maintained effective internal control over financial reporting as of September 26, 2010.
Item 9B.
Item 9B. Other Information
None
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The following table sets forth certain information with respect to the named executive officers and directors of Holdings, their ages and principal occupations for at least the past five years. Directors of Holdings each serve for a term of one year, or until their successors are elected. The officers serve at the discretion of the Board of Directors of Holdings.
Background of Directors and Executive Officers
Jack H. Brown has been President and Chief Executive Officer of Holdings or its predecessor companies since June 1981 and Chairman of the Board since 1989. From September 1978 to June 1981, Mr. Brown served as President of Pantry Food Markets, Inc. and American Community Stores Corporation, Inc., both wholly-owned subsidiaries of Cullum Companies, Inc., a publicly held corporation. From 1972 to 1978, Mr. Brown served as Corporate Vice President of Marsh Supermarkets, Inc., a publicly held corporation. Mr. Brown has been employed in various capacities in the supermarket industry for 57 years. Mr. Brown’s Trust is the sole owner of La Cadena.
Phillip J. Smith was promoted to Executive Vice President and Chief Financial Officer in February 2006. He was Senior Vice President and Chief Financial Officer from November 2000 to February 2006 and was Vice President and Controller of Markets from April 1998 until November 2000. Mr. Smith joined Markets in 1987 as Controller. Mr. Smith has approximately 35 years experience in the supermarket industry. Prior to joining Markets, Mr. Smith was employed by Market Basket Foodstores as Vice President and Chief Financial Officer from 1985 to 1987. From 1975 until 1985, Mr. Smith was employed by various divisions of Cullum Companies, Inc., a publicly held corporation, in various financial capacities.
James W. Lee joined Markets in August 2002 as Group Senior Vice President of Retail Operations and was promoted to Executive Vice President of Retail Operations and Administration in January 2006. Mr. Lee was promoted to President and Chief Operating Officer of Markets effective September 30, 2006. Mr. Lee has over 36 years experience in the supermarket industry. Prior to joining Markets, Mr. Lee was employed with Wild Oats Markets, Inc. between 1997 and 2001 as Chief Operating Officer. Mr. Lee was employed in various operating capacities, including Vice President, Retail, with Ralphs Grocery Company, a division of Kroger Co., from 1972 until 1996.
Item 10. Directors and Executive Officers of the Registrant (contd.)
Background of Directors and Executive Officers (contd.)
Dennis L. McIntyre has been Executive Vice President of Marketing of Markets since December 2007. Mr. McIntyre has served Markets for 33 years in various capacities including Courtesy Clerk, Assistant Manager, Buyer, Assistant Vice President of Marketing from 1994 until 1999, Vice President of Marketing from 1999 to 2000, Senior Vice President of Marketing from 2000 to 2002 and Group Senior Vice President of Marketing of Markets from 2002 to 2007.
George A. Frahm has been Executive Vice President of Retail Operations and Administration of Markets since December 2007. Mr. Frahm has served Markets for 34 years in various capacities including Courtesy Clerk and progressed through a range of retail store and district supervision positions. Mr. Frahm was Vice President of Labor Relations from 1996 until 2001, Senior Vice President of Administration from 2001 to March 2006, Group Senior Vice President of Administration from March 2006 to September 2006 and Group Senior Vice President of Retail Operations and Administration of Markets from 2006 to 2007.
Bruce D. Varner has been a Director of Markets since September 1985 and a Director of Holdings since May 1989. Since February 1997, Mr. Varner has been a partner in the law firm of Varner & Brandt LLP. From 1967 to February 1997, Mr. Varner was a partner in the law firm of Gresham, Varner, Savage, Nolan & Tilden. Mr. Varner specializes in business and corporate matters. Mr. Varner and the law firm of Varner & Brandt LLP have performed legal services in the past for us and we expect such services to continue in the future.
Thomas W. Field, Jr. has been Vice Chairman of the Board of Directors of Holdings since May 1998 and a Director of Holdings since 1994. Mr. Field has been President of Field and Associates since 1989. From 1988 to 1989, Mr. Field was Chairman of the Board, President and Chief Executive Officer of McKesson Corporation and was its President since 1984, and President and Chief Executive Officer from 1986 to 1988. Mr. Field was President of American Stores Company from 1981 to 1984 and was President of Alpha Beta Company from 1976 to 1984. Mr. Field was a Director of American Stores Company from 1979 to 1984. Mr. Field is a nationally recognized and highly regarded supermarket executive and he has served as a director of the Campbell Soup Company. Mr. Field has held various positions in the Supermarket Industry for over 50 years.
Ronald G. Skipper has been a Director of Holdings since April 2007. Mr. Skipper is an attorney and has practiced law for over 42 years in San Bernardino, California where he has resided for over 57 years. Mr. Skipper specializes in litigation matters. Mr. Skipper serves as a Director for Pacific Premier Bank and has been its Chairman of the Board for the past twelve years.
Director Compensation
Annual compensation for non-employee Directors is comprised of an annual retainer and meeting fees.
Annual Board Retainer
Directors receive an annual cash retainer of $50,000 per year.
Meeting Fees
Directors receive a fee of $500 for attending each Board meeting and an additional fee of $500 per committee meeting attended.
Item 10. Directors and Executive Officers of the Registrant (contd.)
Director Compensation For fiscal Year 2010
Jack H. Brown, our Chairman and Chief Executive Officer, is not included in this table because he is an employee of the Company. Mr. Brown’s compensation is shown in the Summary Compensation Table under Item 11
Item 11. Executive Compensation
Compensation Discussion and Analysis
The Compensation Committee of the Board of Directors has the primary responsibility for establishing the compensation paid to our executive officers, including the named executive officers identified in the Summary Compensation table below. This includes base salary, bonus awards, employment agreements, deferred compensation and all other compensation. The Compensation Committee is comprised of Thomas W. Field, Jr., and Bruce D. Varner.
The primary objective of our executive compensation program is to attract, motivate and retain executive officers of outstanding ability. All of the named executive officers with the exception of Mr. Brown have been granted substantial units in our deferred compensation plan and thus have a direct interest in our long-term net profit growth. In light of this participation, there is less need to directly relate salaries and bonuses for the named executive officers to our long-term performance.
Neither management nor the Compensation Committee currently engages any consultant related to executive or director compensation matters. In setting compensation levels, the Compensation Committee considers the overall level of responsibility and performance of the individual executive, our financial performance and other achievements during the most recently completed fiscal year, overall economic conditions, competitive operating conditions and recommendations by the Chief Executive Officer. The Compensation Committee subjectively utilizes the above factors in setting compensation for the named executive officers.
Our executive compensation for the named executive officers includes the following components: base salary, annual bonus plan, deferred compensation awards, retirement benefits, employment agreements and other benefits.
Item 11. Executive Compensation (contd.)
Compensation Discussion and Analysis (contd.)
Salary
Named executive officers are paid a base salary with annual increases at the discretion of the Compensation Committee and the approval of our Board of Directors. In addition to the items outlined above and our financial performance, individual factors are also considered in setting base salaries, including the executive’s experience, achievements, leadership and value to us. There were no raises given to the named executive officers in fiscal 2010.
Bonus
Our executive compensation program includes an annual non-equity incentive cash bonus designed to reward the named executive officers for individual performance and for our overall success. These amounts are recommended subjectively by the Compensation Committee based on the criteria outlined above. The bonuses recommended by the Compensation Committee and approved by the Board of Directors in fiscal 2008 were based on our improved levels of net income and sales. Although the annual bonus award is not targeted as a percentage of the named executive officer’s base salary, the bonus awards in fiscal 2008 ranged from 19% to 92% of base salary. There will be no annual bonuses paid to the named executive officers for fiscal 2009 and 2010.
Deferred Compensation
We maintain a deferred compensation plan to provide additional retention incentives to certain employees of Markets whose performance is considered especially critical to our business. Units in the deferred compensation plan may be granted to a new class of employees, to promoted employees or as additional incentive to existing plan participants. All units have a stated value of $20, and appreciate as described below. Newly granted units vest over 5 years. With the exception of Mr. Brown, all of the named executive officers have been granted units in the deferred compensation plan. Units of the deferred compensation plan can only be redeemed when a participant reaches normal retirement age, becomes permanently totally disabled or to the beneficiary upon the death of the recipient. Subject to vesting provisions of the plan, units are paid in cash either (i) in a lump sum upon a change in control of Holdings; or (ii) if sooner, in either a lump sum or installments (with interest) over a five-year period (as we may determine) following termination of the participant’s employment by reason of retirement, permanent total disability or death. The deferred compensation plan allows for a one-time payment of up to 50% of the stated value of the unit for units that are fully vested. In the event of a change in control, units of the deferred compensation plan will become fully vested and can be redeemed. During the participant’s employment the value of the units increase or decrease in accordance with our net profits. Units for fully vested participants who separate from the Company prior to normal retirement age appreciate at the 12-month Treasury Average rate and can be redeemed when the participant reaches normal retirement age. If a participant voluntarily terminates his or her employment, or is terminated for cause, any awards not fully vested under the plan will be forfeited and no payment will be made. During fiscal 2010, the units in this plan appreciated by 40% of stated value. The units for the above named executives increased by a total of $1.5 million.
Retirement Benefits
We maintain a defined benefit and a defined contribution plan for our non-union employees. The named executive officers participate in both of these plans. Additional details regarding pension plan benefits can be found in the Pension Plan Table and the accompanying narrative description that follows this discussion and analysis.
Item 11. Executive Compensation (contd.)
Compensation Discussion and Analysis (contd.)
Other Benefits
Our group health, dental, vision and life insurance plans are available to non-union eligible full-time and part-time employees. These plans do not discriminate in favor of the named executive officers. Non-employee Directors of our Board of Directors do not participate in these plans.
Employment and Severance Agreements
In June of 2000, Markets entered into Employment Agreements (“Agreements”) with Messrs. Brown, Smith, McIntyre and Frahm. In August of 2002, a similar agreement was entered into with Mr. Lee. Under each of the Agreements, the employee is employed to serve as an officer of Markets and with certain exceptions the Agreements prohibit the employee from employment in any other business except for a parent or subsidiary of Markets. Mr. Brown’s Agreement has an original term of five (5) years which is automatically renewed on July 1 of each year for a five (5) year term. Mr. Smith’s, Mr. McIntyre’s, Mr. Lee’s and Mr. Frahm’s Agreements have an original term of three (3) years, which is automatically renewed for an additional term of three (3) years unless sooner terminated. Each Agreement provides for annual base compensation at the employee’s current level with annual increases plus employee benefits and incentive bonus calculated in accordance with a formula based on Market’s earnings. Each of the Agreements may be terminated by Markets with cause and by either party without cause upon ninety (90) days written notice with the exception of Mr. Brown’s. Mr. Brown’s agreement requires 180 days written notice. If the employment is terminated without cause, the employee’s compensation continues through the expiration of the term of the Agreement then in effect, except in the event of termination by Mr. Brown or by the Board of Directors with the consent of Mr. Brown. If the named executive officer is terminated as a result of a change of control, he is entitled to receive all salary, bonuses and benefits provided under his Agreement for the original term.
Compensation Committee Report
The Compensation Committee has reviewed the Compensation Discussion and Analysis and discussed the analysis with management. Based on its review and discussions with management, the Compensation Committee has recommended to the Board of Directors that the Compensation Discussion and Analysis be included in our annual report on Form 10-K. The report is provided by the following members, who comprise the committee.
SUMMARY COMPENSATION TABLE
PENSION BENEFITS AT SEPTEMBER 26, 2010
NONQUALIFIED DEFERRED COMPENSATION FOR FY2010
(1)
These amounts represent the Company’s contribution in fiscal year 2010 to the named executive officer’s deferred compensation. This includes 20% vesting for units awarded prior to fiscal year 2010 to Mr. Lee, Mr. Smith, Mr. McIntyre and Mr. Frahm and appreciation of 40.1% for all units.
(2)
These amounts represent the one-time withdrawals of half the stated value of some of the vested units in the deferred compensation plan. The stated value of each unit is $20.
(3)
The aggregate balance represents each named executive officer’s deferred compensation balance as of September 26, 2010. This balance represents the vested portion of all units plus appreciation, less any withdrawals.
POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE OF CONTROL
The tables below reflect the amount of compensation that would be paid to each of the named executive officers in the event of termination of such executive’s employment under different circumstances. The amounts shown assume that such termination was effective as of the last day of the last completed fiscal year, and thus includes amounts earned through such time and are estimates of the amounts that would be paid out to the executives upon their termination. The actual amounts to be paid out can only be determined at the time of such executive’s separation.
(1)
Termination of employment by Mr. Brown or by the Board of Directors with the consent of Mr. Brown entitles named executive officers to two weeks of severance pay for every year of service to Markets, up to a maximum of twelve weeks. Severance Pay outlined above represents 12 weeks of pay for Messrs. Brown, Smith, Lee, McIntyre and Frahm.
(2)
In accordance with each named executive officer’s employment and severance agreements, the salary and bonus payable with a change in control represents the sum of five times the base salary and five times the incentive bonus for Mr. Brown and the sum of three times the base salary and three times the incentive bonus for Messrs. Smith, Lee, McIntyre and Frahm with an estimated increase of 10% per year.
(3)
At a change in control, the named executive officer is entitled to the full vested value and appreciation of all deferred compensation, less any withdrawals. The amounts above reflect values as of September 26, 2010.
(4)
Represents continued group health benefits (medical, dental and vision) for the executives and current dependents for a period of up to 5 years for Mr. Brown and 3 years for Messrs. Smith, Lee, McIntyre and Frahm.
Stock Options and SARs
None
Pension Plan
Our Pension Plan for Salaried Employees (the “Pension Plan”) is a non-contributory, defined benefit plan which applies to all salaried employees who have completed one year of qualified service, including Directors who are employees. For each year of credited service, the annual pension to which an employee is entitled under the Pension Plan upon normal retirement at age 65 is an amount equal to three quarters of one percent of the employee’s compensation for each year up to the social security wage base, plus 2.15 percent of the employee’s compensation for each year in excess of the social security wage base. The named executive officers have the following years of credited service under the Pension Plan as of September 26, 2010: Jack H. Brown - 29 years, Phillip J. Smith - 24 years, James W. Lee - 8 years, Dennis L. McIntyre - 33 years and George A. Frahm - 34 years.
The amounts shown in the following table are estimated annual retirement benefits under the Pension Plan (assuming payments are made on the normal life annuity and not under any of the various survivor forms of benefits) based upon retirement at age 65, after various years of service at selected salary levels. Benefits under the Pension Plan do not become fully vested until the employee has five years of credited service with Markets. The Internal Revenue Code of 1986, as amended, places certain limitations on pension benefits that can be paid from a tax-qualified pension plan and trust, as well as the compensation that may be taken into account in determining such benefits. Such limitations are not reflected in the table below. The maximum annual benefit for 2010 retirees with ten or more years of service at retirement is $195,000. The maximum annual compensation that may be considered for 2010 retirees is $245,000.
Pension Plan Table
Employment Agreements
Markets has employment agreements with Messrs. Brown, Lee, Smith, McIntyre and Frahm as described previously. In addition, Markets has entered into employment contracts with 30 additional key members of Management. Mr. Brown has the right to terminate any member of management.
Markets’ severance policies generally provide for two weeks of severance pay to full-time, non-bargaining unit employees for every year of service to Markets, up to a maximum of twelve weeks.
Deferred Compensation Plan
We maintain a deferred compensation plan to provide additional incentive compensation to certain employees of Markets whose performance is considered especially critical to our business. Under the plan, grants may be made by the Compensation Committee and Board of Directors to persons recommended by the Chairman of the Board or Chief Executive Officer. Mr. Brown is not eligible to receive awards. Awards under the plan are for units that have an assigned value. The value of the units awarded under the plan will increase or decrease in accordance with net profits of Holdings. Subject to vesting provisions of the plan, units are paid in cash either (i) in a lump sum upon a change in control of Holdings; or (ii) if sooner, in either a lump sum or installments (with interest) over a five-year period (as we may determine) following termination of the participant’s employment by reason of retirement, permanent total disability or death. Awards under the plan vest after five years, except that upon a participant’s early retirement, permanent total disability or death, awards are considered partially vested at the rate of 20% for each year of employment following the grant. If a participant voluntarily terminates his or her employment, or is terminated for cause, any awards not fully vested under the plan will be forfeited and no payment will be made.
Payments pursuant to units awarded under the plan are based upon the value of a unit at the last fiscal month-end date prior to the date of retirement, permanent total disability or death, except that if such date occurs within two years of the grant the amount of payment, per unit, is limited to the appreciated value of the units during the period plus the amount vested to that date. Upon a change of control, the payment on all units is equal to the full value of the units. The deferred compensation plan allows a one-time payment of up to 50% of the stated value of the unit for units that are fully vested. The stated value of each unit is $20. The election for the one-time payment can be made, at the discretion of the plan beneficiary, annually each October if the election has not been previously made. As of September 27, 2009 and September 26, 2010, there were 899,600 and 889,600 units outstanding, respectively.
Board of Directors
The Board had two standing committees during fiscal 2010.
The Audit Committee recommends the appointment or removal of Holdings’ independent auditors, reviews the scope and results of the independent audit of Holdings, reviews audit fees and reviews changes in accounting policies that have a significant effect on Holdings’ financial statements. The Audit Committee members are Mr. Field, Mr. Varner and Mr. Skipper. Mr. Field is the Chairperson of the Audit Committee and is the Audit Committee’s Financial Expert and is an independent member of the Board.
The Compensation Committee approves compensation and annual performance bonuses paid to the Chief Executive Officer and our Senior Management. The Compensation Committee members are Mr. Varner and Mr. Field. Mr. Varner is the Chairperson of the Compensation Committee.
Code of Ethics
We have adopted a Financial Code of Ethics which has been signed by the CEO, CFO, Controllers and other key personnel. A copy of the Code of Ethics was provided as an exhibit to our fiscal 2004 Report on Form 10-K.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
The following table sets forth, as of December 16, 2010, the number and percentage of outstanding shares of Class A Common Stock beneficially owned by (a) each person known by Holdings to beneficially own more than 5% of such stock, (b) each Director of Holdings, (c) each of the named executive officers, and (d) all Directors and named executive officers of Holdings as a group:
(1)
The 34,552 outstanding shares of Holdings’ Class A Common Stock are owned by La Cadena and may be deemed to be beneficially owned by the partners of La Cadena. The sole equity partner of La Cadena is The Jack H. Brown Revocable Trust. Mr. Brown’s Trust has the sole voting interest and Mr. Brown is the Managing General Partner of La Cadena with the power to vote the shares of Holdings owned by La Cadena on all matters. The address of La Cadena is 3750 University Avenue, Suite 610, Riverside, California 92501.
(2)
The address of Messrs. Brown, Smith, Lee, McIntyre, Frahm, Field, Varner and Skipper is c/o Stater Bros. at 301 S. Tippecanoe Avenue, San Bernardino, California 92408.
Change of Control Arrangements
None
Item 13.
Item 13.
Certain Relationships and Related Transactions
Mr. Bruce D. Varner and the law firm of Varner & Brandt LLP, of which Mr. Varner is the Senior Partner, have performed legal services in the past for Holdings and its subsidiaries. The total cost of such legal services incurred by us was $2.8 million, $1.8 million and $2.4 million in fiscal 2008, 2009 and 2010, respectively. In addition, Mr. Varner was paid Director fees of $54,000 in each of the fiscal years 2008, 2009 and 2010. We believe that the terms and costs of such legal services provided by Mr. Varner and the law firm of Varner & Brandt LLP were at least as fair to us as could have been obtained from unaffiliated law firms. We expect such services to continue in the future.
On both September 25, 2008 and November 17, 2009, we paid a $5.0 million dividend to La Cadena.
The 34,552 outstanding shares of Holdings’ Class A Common Stock are owned by La Cadena and may be deemed to be beneficially owned by the partner of La Cadena. The sole partner of La Cadena is The Jack H. Brown Revocable Trust. Mr. Brown’s Trust has the sole interest and Mr. Brown is the Managing General Partner of La Cadena with the power to vote the shares of Holdings owned by La Cadena on all matters.
Item 14.
Item 14.
Independent Registered Public Accounting Firm Fees and Services
Audit Fees
Ernst & Young LLP fees for audit services aggregated $839,000 in fiscal 2010 and $695,000 in fiscal 2009 for services associated with the annual audit of Holdings and Markets and reviews of Holdings quarterly reports on Form 10-Q.
Audit Related Fees
Ernst & Young LLP billed us in aggregate $2,000 in fiscal 2010 for online subscriptions and $2,000 in fiscal 2009 for online subscriptions
Tax Fees
Ernst & Young LLP billed us in aggregate $34,000 in fiscal 2010 and $38,000 in fiscal 2009 for tax compliance, tax advice and tax planning services.
All Other Fees
Ernst & Young LLP billed us an aggregate of $55,000 in fiscal 2010 related to LAMBRA tax credits and a review of the Dairy Transaction and an aggregate of $125,000 in fiscal 2009 related LAMBRA tax credits and a review of the Dairy Transaction.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules
(1)
Financial Statements
See Financial Statement Index included in Item 8 of Part II of this Form 10-K.
(2)
Financial Statement Schedules
The Financial Statement Schedules required by Item 15(d) for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission, are not required under the related instructions or are inapplicable and therefore, have been omitted.
(3)
Exhibits
Exhibits as required by Item 15(c) are as follows:
Item 15.
Exhibits and Financial Statement Schedules (contd.)
Item 15.
Exhibits and Financial Statement Schedules (contd.)
Item 15.
Exhibits and Financial Statement Schedules (contd.)
STATER BROS. HOLDINGS INC.
FOR THE FISCAL YEAR ENDED SEPTEMBER 26, 2010
FORM 10-K
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 the dates indicated.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors of
Stater Bros. Holdings Inc.
We have audited the accompanying consolidated balance sheets of Stater Bros. Holdings Inc. as of September 27, 2009 and September 26, 2010, and the related consolidated statements of income, stockholder’s equity, and cash flows for the 52-week periods ended September 28, 2008, September 27, 2009 and September 26, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with 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. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and 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 Stater Bros. Holdings Inc. at September 27, 2009 and September 26, 2010, and the consolidated results of its operations and its cash flows for the 52-week periods ended September 28, 2008, September 27, 2009 and September 26, 2010, in conformity with U.S. generally accepted accounting principles.
/s/ Ernst & Young LLP
Irvine, California
December 15, 2010
STATER BROS. HOLDINGS INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
See accompanying notes to consolidated financial statements.
STATER BROS. HOLDINGS INC.
CONSOLIDATED BALANCE SHEETS (contd.)
(In thousands, except share amounts)
See accompanying notes to consolidated financial statements.
STATER BROS. HOLDINGS INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share and share amounts)
See accompanying notes to consolidated financial statements.
STATER BROS. HOLDINGS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
See accompanying notes to consolidated financial statements.
STATER BROS. HOLDINGS INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDER’S EQUITY
(In thousands except shares)
See accompanying notes to consolidated financial statements.
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 26, 2010
Note 1 - The Company and Summary of Significant Accounting Policies
Description of Business
Stater Bros. Holdings Inc. (the “Company”) is engaged primarily in the operation of retail supermarkets. As of September 26, 2010, the Company operated 167 retail grocery supermarkets under the name “Stater Bros. Markets.” The Company’s supermarkets are located in the Southern California counties of San Bernardino, Riverside, Los Angeles, Orange, San Diego and Kern. The Company and its predecessor companies have operated retail grocery stores under the “Stater Bros. Markets” name in Southern California since 1936.
Ownership of the Company
La Cadena Investments (“La Cadena”), a California general partnership whose sole voting partner is the Jack H. Brown Revocable Trust, holds all of the Company’s issued and outstanding capital stock. Mr. Jack H. Brown, the Chairman of the Board, President and Chief Executive Officer of the Company, is the Managing General Partner of La Cadena.
Principles of Consolidation and Subsequent Events
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Stater Bros. Markets (“Markets”) and Stater Bros. Development, Inc. (“Development”) and Markets’ wholly-owned subsidiaries, Super Rx, Inc. (“Super Rx”) and SBM Dairies, Inc. (“Dairies”). During fiscal year 2010, the Company changed the legal name of Dairies from Santee Dairies, Inc. to SBM Dairies, Inc. All significant inter-company transactions have been eliminated in consolidation. The Company has evaluated the impact of subsequent events and determined that, other than its debt refinancing as disclosed in “Note 2 - New Debt Issuance and Early Extinguishment of Debt”, it did not have any subsequent events that needed to be disclosed in its consolidated financial statements.
Reclassifications
Certain line items in the prior periods balance sheet and cash flow statements have been reclassified to conform to the current presentation related to Dairies’ asset sale, accrued interest and accrued payroll and related expenses. Substantially all of the assets and certain liabilities of Dairies had been classified as “Held for Sale” prior to their disposal on October 11, 2009 as described in “Note 15 - Asset Sale” in the notes to these consolidated financial statements.
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.
Fiscal Year
The Company’s fiscal year ends on the last Sunday in September.
Cash and Cash Equivalents
Cash and cash equivalents are reflected at cost, which approximates their fair value, and consist primarily of overnight repurchase agreements, certificates of deposit and money market funds with maturities of less than three months when purchased.
Restricted Cash
Restricted cash represents cash that has been set aside as collateral on certain workers’ compensation and general liability self-insurance reserves. Interest earned on the restricted cash is controlled by the Company and is included in cash and cash equivalents.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market.
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 1 - The Company and Summary of Significant Accounting Policies (contd.)
Receivables
Receivables represent amounts expected to be received during the next operating cycle of the Company, net of allowance for doubtful accounts. The Company provides specific reserves for accounts deemed to be uncollectible and provides general reserves based on historical experiences. The carrying amount reported in the balance sheet for receivables approximates their fair value.
Long-Lived Assets
The Company reviews the recoverability of its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the estimated future, undiscounted cash flows from the use of an asset are less than its carrying value, a write-down is recorded to reduce the related asset to estimated fair value.
Property and Equipment
Property and equipment are stated at cost and are depreciated or amortized, principally on the straight-line basis, over the estimated useful lives of the assets. Leasehold improvements placed in service at the commencement of the lease are amortized over the lesser of their economic useful lives or the initial term of the lease. Other leasehold improvements are amortized over the lesser of their economic useful lives or the remaining lease term including any option period that is reasonably assured of being exercised. Assets under capital leases are amortized over the lesser of their estimated economic useful life or the initial lease term.
The estimated economic lives are as follows:
Deferred Debt Issuance Costs
Direct costs incurred as a result of financing transactions are capitalized and amortized to interest expense over the terms of the applicable debt agreements.
Deferred Compensation Plan
The Company maintains the Stater Bros Holdings Inc. Phantom Stock Plan (the “deferred compensation plan”). It is the Company’s policy to expense awarded units under the deferred compensation plan to the extent that they vest and appreciate during the accounting period.
Self-Insurance Reserves
The Company is primarily self-insured, subject to certain retention levels for workers’ compensation, automobile and general liability costs. The Company is covered by umbrella insurance policies for catastrophic events. The Company records its self-insurance liability based on the claims filed and an estimate of claims incurred but not yet reported. The estimates used by management are based on the Company’s historical experiences as well as current facts and circumstances. The Company uses third party actuarial analysis in making its estimates. Actuarial projections and the Company’s estimate of ultimate losses are subject to a high degree of variability. The variability in the projections and estimates are subject to, but not limited to, such factors as judicial and administrative rulings, legislative actions, and changes in compensation benefits structure. The Company discounted its workers’ compensation, automobile and general liability insurance reserves at a discount rate of 5.50% in fiscal 2009 and 5.00% in fiscal 2010. The Company is self-insured, subject to certain retention levels, for health care costs of eligible non-bargaining unit employees. Such health care reserves are not discounted.
Income Taxes
The Company provides for deferred income taxes as timing differences arise between income and expenses recorded for financial and income tax reporting purposes. The Company records a valuation allowance to reflect the estimated amount of deferred tax assets that more-likely-than-not will not be realized.
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 1 - The Company and Summary of Significant Accounting Policies (contd.)
Revenue Recognition
The Company recognizes revenue from the sale of its products at the point of sale to the customer. Sales are recognized net of any promotional discounts given to the customer. Prescription sales are recognized when prescriptions are adjudicated by the third party insurer and when co-payment is received. The Company recognizes a liability when Stater Bros.’ gift cards (“gift cards”) are sold and recognizes sales revenue when the gift cards are used to purchase its products. Gift cards do not have an expiration date and gift card balances do not reduce because of inactivity or time. The Company does not charge service fees on the gift cards. Gift cards whose likelihood of redemption is deemed to be remote, due primarily to periods of inactivity, are recognized into income.
Cost of Goods Sold
Included in cost of goods sold are direct product purchase costs, all in-bound freight costs, all direct receiving and inspection costs, all quality assurance costs, all warehousing costs and all costs associated with transporting goods from the Company’s distribution center to its stores, net of earned vendor rebates and allowances. The Company recognizes, as a reduction to cost of goods sold, certain rebates and allowances (“allowances”) from its vendors as the allowances are earned. Allowances are earned by promoting certain products or by purchasing specified amounts of product. The Company records a liability for allowance funds that have been received but not yet earned. Included as a reduction in cost of goods sold for fiscal 2008, 2009 and 2010 is $5.8 million, $4.6 million and $2.9 million, respectively, of advertising costs in excess of the fair value of the co-operative advertising.
Selling, General and Administrative Expenses
Included in selling, general and administrative expenses are all store operation costs which include all store labor costs associated with receiving, displaying and selling the Company’s products at the store level; all advertising costs, net of the portion of co-operative advertising allowances directly related to the fair value of the advertising; certain salary, wages and administrative costs associated with the purchasing of the Company’s products and all security, management information services, accounting and corporate management costs.
As noted under “Cost of Goods Sold”, the Company includes all purchasing and distribution costs to deliver the product for sale to its stores in cost of goods sold, except for certain salary, wages and administrative costs associated with the purchasing of its products. The amount of salary, wages and administrative costs associated with the purchase of its products included in selling, general and administrative costs was $1.2 million in each fiscal year 2008, 2009 and 2010.
Vendor Rebates and Allowances
The Company receives certain allowances from its vendors that relate to the purchase and promotion of certain products. All allowances, except for advertising allowances described under “Advertising Allowances”, are recognized as a reduction in cost of goods sold as the performance is completed and inventory sold. Allowances, such as slotting fees, which are tied to the promotion of certain products are recognized as reductions in cost of goods sold as the Company meets the required performance criteria. Allowances that are based upon purchase or sales volumes are recognized as reductions in cost of goods sold as the products are sold. The Company receives lump-sum payments from vendors for the promotion or purchase of products over multi-year periods. The Company records a liability for unearned allowances and recognizes, as a reduction in cost of goods sold, these allowances over time as the criteria of these contracts are met.
Advertising
The Company’s advertising costs, net of vendor allowances for co-operative advertising, are recognized in the period the advertising is incurred and are included in selling, general and administrative expenses. Advertising costs, net of vendor allowances, were $23.7 million, $22.2 million and $20.4 million in fiscal 2008, 2009 and 2010, respectively.
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 1 - The Company and Summary of Significant Accounting Policies (contd.)
Advertising Allowances
A significant portion of the Company’s advertising expenditures is in the form of twice weekly print advertisements. The Company distributes its print ads through inserts in local newspapers, in direct mailers and as handouts distributed in its stores. The Company receives co-operative advertising allowances from vendors for advertising specific vendor products over specific periods of time. The Company recognized the portion of co-operative advertising allowances directly related to the fair value of advertising as a reduction in advertising costs. The Company analyzes, on a monthly basis, the direct out-of-pocket costs for printing and distributing its print ads. Using the number of ads in a typical twice weekly advertisement, the actual direct costs of an individual advertisement is determined. The cost determined is deemed to be the fair value of advertising. The amount of co-operative advertising allowance recognized as a reduction in advertising expense was $4.4 million in fiscal 2008, $2.6 million in fiscal 2009 and $1.6 million in fiscal 2010. The amount of advertising costs in excess of the fair value of advertising is recorded as a reduction in cost of goods sold.
Leases
Certain of the Company’s operating leases provide for minimum annual payments that change over the life of the lease. The aggregate minimum annual payments are expensed on the straight-line basis over the minimum lease term. The Company recognizes a deferred rent liability for minimum step rents when the amount of rent expense exceeds the actual lease payments and it reduces the deferred rent liability when the actual lease payments exceeds the amount of straight-line rent expense. Rent holidays and tenant improvement allowances for store remodels are amortized on the straight-line basis over the initial term of the lease and any option period that is reasonably assured of being exercised.
Note 2 - New Debt Issuance and Early Extinguishment of Debt
Issuance of New Notes
On November 29, 2010, the Company completed the sale of $255 million in aggregate principal amount of 7 3/8% Senior Notes due November 15, 2018 (the “New Notes”) in a private offering.
The New Notes are unregistered and unsecured obligations of the Company and are guaranteed by Markets and Development and the Company’s indirect subsidiaries, Dairies and Super Rx. The Company incurred $6.4 million of debt issuance costs related to the issuance of the 7 3/8% Senior Notes, which will be amortized over the term of the New Notes to interest expense.
Issuance of New Credit Facility
On November 29, 2010, the Company entered into a new $245 million senior secured credit facility (the “New Credit Facility”) with Bank of America, N.A., as administrative agent and a lender. The New Credit Facility consists of a four-year $145 million term loan (the “Term Loan”) and a $100 million revolving credit facility (the “New Revolving Credit Facility”). The New Credit Facility replaced the Company’s existing $100 million credit facility as of November 29, 2010. The New Credit Facility is secured by substantially all of the Company’s personal property excluding certain intangible assets consisting of trademarks and shares of capital stock. The New Credit Facility is guaranteed by the Company, Development, Super Rx and Dairies.
The Term Loan bears interest at Eurodollar Rate plus 2.50% or the Base rate plus 1.50% (as defined in the New Credit Facility) and the interest is payable quarterly in arrears and includes mandatory quarterly principal payments of 5.0% in each of the first two years of the agreement and 10.0% in each year three and four of the agreement. The Term Loan also includes additional mandatory principal payments on the Term Loan based on a percentage of “excess cash flow” as defined in the New Credit Facility”. The Term Loan is due November 29, 2014 with any remaining outstanding principal amounts under the Term Loan due as of that date. The security held under the New Credit Facility is held until the Term Loan is paid in full. The Company incurred $2.1 million of debt issuance cost related to the Term Loan which will be amortized over the term of the Term Loan.
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 2 - New Debt Issuance and Early Extinguishment of Debt (contd.)
Issuance of New Credit Facility (contdl)
Subject to certain restrictions, the entire amount of the New Revolving Credit Facility may be used for loans, letters of credit, or a combination thereof. Borrowings under the New Revolving Credit Facility are secured and will be used for working capital, certain capital expenditures and other general corporate purposes. Letters of credit issued under the letter of credit facility are expected to be used for workers’ compensation insurance obligations and may be used for new store construction and certain other corporate purposes. The availability of the loans and letters of credit is subject to certain borrowing restrictions.
Loans under the New Revolving Credit Facility bear interest at a rate based upon either (i) the “Base Rate” (defined as the higher of (a) the federal funds rate plus 0.50% and (b) the Bank of America “prime rate”), plus 1.50%, or (ii) the “Eurodollar Rate” (defined as the British Bankers Association LIBOR Rate adjusted for the maximum reserve requirement for Eurocurrency funding), plus 2.50%. For Eurodollar Rate loans, the Company will be entitled to select interest periods of one, two, three, six, nine or twelve months, subject to availability.
The terms and provisions relating to covenants, including restricted payments, and events of defaults under the New Revolving Credit Facility are consistent with those of the existing credit facility.
The Company’s $49.8 million of outstanding letters of credit continue to be issued and outstanding under the New Revolving Credit Facility.
The New Revolving Credit Facility will cease to be available and will be payable in full on November 29, 2014.
Early Extinguishment of Debt
On November 29, 2010, the Company used the proceeds from the New Notes and the New Term Loan and cash on hand to make a payment of $496.9 million to purchase and make tender payments on approximately $477.5 million of outstanding principal of its $525 million outstanding aggregate principal amount of 8.125% Senior Notes due 2012 (the “Old Notes”) that were validly tendered as of November 26, 2010. The tender payment included a consent fee of $10 per $1,000 of the Old Notes tendered. The Company will record $1.8 million as interest expense related to debt purchase for the consent fee paid on the Old Notes that were validly tendered. The Company also paid $17.7 million of accrued interest related to the tendered Old Notes. On December 13, 2010, the Company completed its tender offer on the Old Notes and made a payment of $2.4 million to redeem $2.4 million of Old Notes that were validly tendered. Also the Company paid $0.1 million of accrued interest on these tendered Notes.
In connection with the Old Notes that were tendered and purchased, the Company will expense approximately $3.2 million of unamortized deferred offering costs related to the Old Notes in the first quarter of fiscal 2011.
On November 29, 2010, the Company issued a call notice to early redeem and retire all of the remaining approximately $47.5 million outstanding Old Notes. The call date for redemption of the remaining outstanding Old Notes is January 14, 2011.
As a result of the early extinguishment of debt, $132.3 million of previously long-term debt has been classified as current portion of long-term debt on the September 26, 2010 consolidated balance sheet.
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 3 - Debt
Long-term debt consisted of the following:
Interest on the 8.125% Senior Notes due June 2012 (the “8.125% Senior Notes”), is payable semi-annually in arrears on June 15 and December 15. Principal on the 8.125% Senior Notes is due in fiscal 2012.
Interest on the 7.75% Senior Notes is payable semi-annually in arrears on April 15 and October 15. Principal on the 7.75% Senior Notes is due in fiscal 2015.
Interest capitalized during fiscal 2008 and 2009 amounted to $11.3 million and $0.5 million, respectively. There was no capitalized interest in fiscal 2010. Interest expense incurred, before the effect of capitalized interest, amounted to $68.8 million in both fiscal years 2008 and 2009 and amounted to $68.5 million in fiscal year 2010.
The Company is subject to certain covenants associated with its 8.125% Senior Notes and its 7.75% Senior Notes. As of September 26, 2010, the Company was in compliance with all such covenants.
The Notes are guaranteed by the Company’s subsidiaries Markets and Development, and the Company’s indirect subsidiaries Super Rx and Dairies (each a “subsidiary guarantor”, and collectively, the “subsidiary guarantors”). Condensed consolidating financial information with respect to the subsidiary guarantors is not provided because the Company has no independent assets or operations, the subsidiary guarantees are full and unconditional and joint and several and there are no subsidiaries of the Company other than the subsidiary guarantors.
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 4 - Credit Facilities
On May 4, 2010, the Company and Markets entered into the Third Amended and Restated Credit Agreement with Bank of America, N.A. (“Bank of America”), as sole and exclusive administrative agent and sole initial lender, consisting of a three-year unsecured revolving credit facility in a principal amount of up to $100 million (the “Credit Facility”), which replaced the Company’s previous credit facility.
The Credit Facility is guaranteed by all of the Company’s existing and future material subsidiaries, including Development and the Company’s indirect subsidiary Super Rx. Subject to certain restrictions, the entire amount of the Credit Facility may be used for loans, letters of credit, or a combination thereof. Borrowings under the Credit Facility are unsecured and may be used for working capital, certain capital expenditures and other general corporate purposes. Letters of credit issued under the letter of credit facility are expected to be used to support obligations incurred in connection with the construction of stores and workers’ compensation insurance obligations. The availability of the loans and letters of credit is subject to certain borrowing restrictions.
Loans under the Credit Facility bear interest at a rate based upon either (i) the “Base Rate” (defined as the higher of (a) the federal funds rate plus 0.50% and (b) the rate of interest publicly announced by Bank of America as its “prime rate”), plus 1.00%, or (ii) the “Eurodollar Rate” (defined as the British Bankers Association LIBOR Rate for deposits in dollars, adjusted for the maximum reserve requirement for Eurocurrency funding), plus 1.75%. For Eurodollar Rate Loans, the Eurodollar Rate will apply for periods, as selected by the Company, of one, two, three or six months (but in any event not later than the maturity date of the Credit Facility).
The Credit Facility requires the Company to meet certain financial tests, including minimum net worth and the maintenance of minimum earnings levels. The Credit Facility contains covenants which, among other things, limit the ability of the Company and its subsidiaries to (i) incur indebtedness, grant liens and guarantee obligations, (ii) enter into mergers, consolidations, liquidations and dissolutions, asset sales, investments, leases and transactions with affiliates, and (iii) make restricted payments. Markets is not limited in its ability to transfer assets in the form of loans, advances or cash dividends to the Company. The Credit Facility also contains covenants that apply to the Company and its subsidiaries, and the Company is a party to the Credit Facility for purposes of these covenants. These covenants, among other things, limit the ability of the Company and its subsidiaries to incur indebtedness, make restricted payments, enter into transactions with affiliates, and make certain amendments to the Indentures governing the 8.125% Senior Notes and the 7.75% Senior Notes (“Notes Indentures”).
As of September 26, 2010, the Company had $49.8 million of outstanding letters of credit and it had $50.2 million available under the Credit Facility and the Company was in compliance with all restrictive covenants under the Credit Facility. However, there can be no assurance that the Company will be able to achieve the expected operating results or implement the capital expenditure strategy upon which future compliance with such covenants is based.
The Company had no short-term borrowings outstanding as of September 26, 2010 and the Company did not incur any short-term borrowings during the fiscal year ended September 26, 2010.
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 5 - Leases
The Company leases the majority of its retail stores. Certain of the operating leases provide for minimum annual payments that change over the life of the lease. The Company expenses rental costs that are incurred during new store construction in the period incurred.
The aggregate minimum annual lease payments are expensed on the straight-line basis over the minimum lease term. The Company recognizes a deferred rent liability for minimum step rents when the amount of rent expense exceeds the actual lease payment and it reduces the deferred rent liability when the actual lease payment exceeds the amount of straight line rent expense. Rent holidays and tenant improvement allowances for store remodels are amortized on the straight-line basis over the initial term of the lease and any option period that is reasonably assured of being exercised. Certain of the Company’s operating leases are subject to contingent rent based upon the sales volume of the store subject to the lease. The Company accrues for contingent rent when the amount of contingent rent exceeds minimum lease payments. Primary lease terms range from 3 to 55 years and substantially all leases provide for renewal options.
Following is a summary of future minimum lease payments as of September 26, 2010:
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 5 - Leases (contd.)
Rental expense and sublease income were as follows:
The Company has a fifteen year sublease with a third party (the “sublessee”) ending in May 2023, which contains three, five year lease options, for the lease of the Company’s former headquarters building and certain former distribution facilities located in Colton, California (the “Former Facilities”). The current lease on the Former Facilities contains multiple lease options that gives the Company the right to control the property through May 2038. The sublessee assumed all lease payments and other liabilities under the lease. The Company’s lease payments on the Former Facilities are included in the “Operating leases minimum payments” and the sublessee’ lease payments are included in “Noncancelable sublease income” in the schedule above.
Note 6 - Income Taxes
The provision for income taxes consisted of the following:
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 6 - Income Taxes (contd.)
Components of deferred income taxes are as follows:
The Company establishes deferred tax liabilities for anticipated tax timing differences where payment of tax is anticipated. Such amounts represent a reasonable provision for taxes ultimately expected to be paid, and the amounts may be adjusted over time as additional information becomes known.
The Company does not have any material tax positions that did not meet a “more-likely-than-not” recognition threshold. As such, the Company has not recorded any liabilities for uncertain tax positions. During fiscal 2010, there have been no material changes to the amount of uncertain tax positions.
The Company recognizes interest and penalties related to income tax deficiencies or assessments by taxing authorities for any underpayment of income taxes separately from income tax expenses as either interest expense or other operating expenses.
For federal tax purposes, the Company is subject to review on its fiscal 2007 through fiscal 2010 tax returns. During fiscal 2010, the State of California Franchise Tax Board (“FTB”) concluded their review of the Company’s fiscal 2006 state return and made no changes to the Company’s reported taxes. For state tax purposes, the Company is subject to review by the FTB of its fiscal 2007 through fiscal 2010 tax returns.
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 7 - Retirement Plans
Pension and Medical Plans
The Company has a Noncontributory Defined Benefit Pension Plan (the “Pension Plan”) covering substantially all non-union employees. The plan provides for benefits based on an employee’s compensation during the eligibility period while employed with the Company. The Company’s funding policy for this plan is to contribute annually at a rate that is intended to provide sufficient assets to meet future benefit payment requirements.
The Company also maintains an Early Retiree Medical Premium Reimbursement Plan (the “Medical Plan”) to provide reimbursement for medical insurance premiums for employees who retire before their Social Security retirement age. The maximum benefit under the plan is $500 per month per retired employee for a maximum of 120 months.
Amounts recognized in accumulated other comprehensive income/loss for the qualified defined pension plan:
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 7 - Retirement Plans (contd.)
Pension and Medical Plans (contd.)
The following tables provide a reconciliation of the changes in the pension plan’s benefit obligation and fair value of assets for fiscal years ending and a statement of the funded status as of the fiscal years ended September 27, 2009 and September 26, 2010:
Market related value of plan assets is calculated using fair market value, as provided by a third-party trustee. The plan’s investments include cash, which earns interest, governmental securities and corporate bonds and securities.
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 7 - Retirement Plans (contd.)
Pension Plan
The following table provides the components of fiscal 2008, 2009 and 2010 net pension expense:
Expenses recognized for the Pension Plan were $4.0 million, $3.6 million and $5.7 million in fiscal years 2008, 2009 and 2010, respectively. Pension expenses included trustee and administrative expenses for the Pension Plan of $0.3 million, $0.4 million and $0.4 million in fiscal years 2008, 2009 and 2010, respectively.
The Company has adopted and implemented an investment policy for the defined benefit pension plan that incorporates a strategic long-term asset allocation mix designed to meet the Company’s long-term pension requirements. This asset allocation policy is reviewed annually and, on a regular basis, actual allocations are rebalanced to the prevailing targets. As of September 26, 2010, the strategic target asset allocation is 67% fixed income and 33% equity. The following table summarizes actual allocations for the Company’s plan at the end of fiscal 2009 and fiscal 2010:
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 7 - Retirement Plans (contd.)
Pension Plan (contd.)
The above table sets forth by level, within the fair value hierarchy, the Pension Plan’s assets at fair value. The Company was unable to obtain the information necessary to prepare a reconciliation of the beginning and ending balances for investments classified as Level 3.
Generally accepted accounting principals (“GAAP”) establishes a fair value hierarchy that priorities the inputs used to measure fair value. The three levels of the fair value hierarchy defined in the standards are as follows:
Level 1 - Quoted prices are available in active markets for identical assets or liabilities;
Level 2 - Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable;
Level 3 - Unobservable pricing inputs in which little or no market activity exists, therefore requiring an entity to develop its own assumptions about the assumptions that market participants would use in pricing an asset or liability.
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 7 - Retirement Plans (contd.)
Pension Plan (contd.)
The investment policy is for the fund to earn long-term investment returns in excess of inflation, which is at least equal to the actuarial discount rate used to calculate the plan’s liability. The protection of principal is the focus of the investment policy.
The Company expects to contribute approximately $2.6 million to its defined benefit pension plan during fiscal 2011.
Estimated Future Benefit Payments
The following benefit payments, which reflect expected future service as appropriate, are expected to be paid:
Medical Plan
The following table provides the components of fiscal 2008, 2009 and 2010 net periodic benefit costs:
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 7 - Retirement Plans (contd.)
Medical Plan (contd.)
Expenses recognized for the medical plan were $0.2 million in each fiscal year 2008, 2009 and 2010.
The Company expects to contribute approximately $0.1 million to the medical plan during fiscal 2011.
Estimated Future Benefit Payments
The following benefit payments, which reflect expected future service as appropriate, are expected to be paid:
Profit Sharing Plan
The Company has a noncontributory defined contribution profit sharing plan covering substantially all non-union employees. Union employees may participate if their collective bargaining agreement specifically provides for their inclusion. The Company may contribute up to 7.5% of total compensation paid or accrued during the year to each plan participant subject to limitations imposed by the Internal Revenue Code. The Company recognized expenses for this plan in the amount of $1.2 million in fiscal 2008, $1.0 million in fiscal 2009 and $0.5 million in fiscal 2010.
Multi-Employer Plans
The Company also contributes to multi-employer defined benefit retirement plans in accordance with the provisions of the various labor agreements that govern the plans. Contributions to these plans are generally based on the number of hours worked. Information for these plans as to vested and non-vested accumulated benefits and net assets available for benefits is not available.
The Company’s expense for these retirement plans and health and welfare plans consisted of the following:
The Company’s employer contributions fluctuate as a result of changes to employer contributions outlined in collective bargaining agreements.
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 8 - Labor Relations
The Company’s collective bargaining agreements with the UFCW were renewed in March 2007 and extends through March 2011. The Company’s collective bargaining agreement with the International Brotherhood of Teamsters was renewed in October 2010 and expires in September 2015. Substantially all of our employees are covered by collective bargaining agreements.
Note 9 - Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and Cash Equivalents
The carrying amount approximates fair value because of the short-term maturity of these instruments.
Receivables
The carrying amount approximates fair value because of the short-term maturity of these instruments.
Long-Term Receivable, Current Portion
Although market quotes for the fair value of the Company’s long-term receivable are not readily available, the Company valued its long-term receivable based on a discounted cash flow approach applying a discount rate that approximates long-term market rates.
Long-Term Debt and Capital Lease Obligations
The fair value of the 8.125% Senior Notes and the 7.75% Senior Notes, are based on quoted market prices. Although market quotes for the fair value of the Company’s capitalized lease obligations are not readily available, the Company believes the stated value approximates fair value.
The estimated fair values of the Company’s financial instruments are as follows:
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 10 - Litigation Matters
In the ordinary course of business, the Company is party to various legal actions which it believes are incidental to the operation of its business and the business of its subsidiaries. The Company records an appropriate provision when the occurrence of loss is probable and can be reasonably estimated. The Company believes that the outcome of such legal proceedings to which it is currently a party will not have a material adverse effect upon its results of operations or its consolidated financial condition.
In December 2008, an action by Dennis M. O’Connor, et al. was filed in the Los Angeles Superior Court against Santee Dairies, Inc., dba Heartland Farms (now SBM Dairies, Inc.) seeking individual and potential class action monetary damages for time spent by non-exempt hourly paid employees for changing into and out of sanitary uniforms. On September 23, 2010 following mediation the case was settled. Under the settlement agreement, the settlement amount will be paid pursuant to procedures for filing and approval of claims for members of the certified class with a portion of any unclaimed amounts returned to SBM Dairies, Inc. The full settlement amount has been recorded in the Company’s consolidated financial statements.
Note 11 - Long-Term Receivable
During the second quarter of fiscal 2010, Markets entered into the Comprehensive Tri-Party Termination Infrastructure Reimbursement Agreement (the “Termination Agreement”) with the Inland Valley Development Agency (the “IVDA”) and Hillwood/San Bernardino, LLC (“Hillwood”) to terminate commitments with Hillwood under certain obligations and settle outstanding financial issues among the parties arising from several agreements previously entered into with Hillwood and the IVDA in connection with the development of the Distribution Center. As part of the Termination Agreement, the amount previously due from the IVDA for tax increment reimbursement related to the construction of the Distribution Center was negotiated downward from $18.9 million to $17.7 million. The $17.7 million receivable was classified as a current asset and the $1.2 million adjustment out of long-term receivable was recorded to “Building and improvements” in the Company’s June 27, 2010 consolidated balance sheet. Under the Termination Agreement, Markets paid approximately $0.7 million to Hillwood as reimbursement for shared improvement costs and any further financial commitments between Markets and Hillwood were terminated. The $0.7 million reimbursement was recorded to “Buildings and improvements” in the Company’s consolidated balance sheet.
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 12 - Deferred Compensation Plan
The Company maintains a deferred compensation plan for certain executives of Markets. Mr. Jack H. Brown is not eligible to receive awards. Awards under the plan are for units that have an assigned value. Awards under the plan vest after five years, except that upon a participant’s early retirement, permanent total disability or death, awards are considered partially vested at the rate of 20% for each year of employment following the grant. If a participant voluntarily terminates his or her employment, or is terminated for cause, any awards not fully vested under the plan will terminate and no payment will be made. As of September 27, 2009 and September 26, 2010, there were 899,600 and 889,600 units outstanding, respectively. The Company recognized an expense for the plan of $12.1 million, $11.0 million and $7.9 million in 2008, 2009 and 2010, respectively.
Note 13 - Related Party Transactions
On both September 25, 2008 and November 17, 2009, the Company paid a $5.0 million dividend to La Cadena.
The Company paid legal fees of $2.8 million, $1.8 million and $2.4 million in fiscal 2008, 2009 and 2010, respectively, to the law firm of Varner & Brandt LLP. Mr. Bruce D. Varner is the Senior Partner of Varner & Brandt LLP and is also a director of the Company. Mr. Varner received director fees of $54,000 in each fiscal year 2008, 2009 and 2010.
Note 14 - Stock Redemption
On September 25, 2008, the Company redeemed 618 shares of its Class A Common Stock for $8.2 million. The redemption was for shares distributed to the Moseley Trust by La Cadena.
On December 28, 2009, the Company redeemed 600 shares of its Class A Common Stock for $8.0 million. The redemption was for shares distributed to the Moseley Trust by La Cadena.
As of September 26, 2010, the Company had the ability under the Credit Facility to make restricted payments, including dividends of up to $38.0 million.
Note 15 - Asset Sale
On October 11, 2009, the Company sold substantially all of the assets of Dairies to subsidiaries of Dean Foods (“Dean Foods”) for $88.0 million in cash, subject to a working capital adjustment, and assumption of certain liabilities including substantially all of Dairies’ current liabilities, which included accounts payable. In the second quarter of fiscal 2010, the purchase price was adjusted upward by approximately $1.5 million due to an adjustment made for working capital. Dairies’ assets which were sold consisted primarily of accounts receivable, inventory and property and equipment. The Company incurred approximately $3.8 million in transaction and other fees related to the transaction and recognized a gain, net of tax, of approximately $5.6 million. The pre-tax gain from the sale of Dairies’ assets is included in “Gain on sale of dairy assets” within the consolidated statements of income. Dairies retained responsibility for all workers compensation claims through the date of the transaction.
Also on October 11, 2009, the Company entered into a ten year Product Purchase Agreement (the “PPA”) with Dean Foods to purchase substantially all of its milk products sold in its supermarkets from Dean Foods. The purchase prices under the PPA are deemed to approximate market pricing.
As of October 11, 2009, the Company ceased all dairy manufacturing operations.
Markets and Super Rx have similar customers, regulatory requirements and delivery methods to customers and are included together as one reportable segment. Prior to the Dairy Transaction, Dairies was a separate reportable segment of the Company. As operating activities of Dairies have ceased and operating results from September 28, 2009 to October 11, 2009 are not material to the overall financial statements of the Company taken as a whole, the Company no longer has separate reportable segments to disclose.
STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (contd.)
Note 16 - Quarterly Results (unaudited)
Quarterly results for fiscal 2008, 2009 and 2010 are as follows (in thousands except share and per share amounts):